Page 1 Report No. 37278-MK Former Yugoslav Republic of Macedonia Issues in Urban and Municipal Development A Policy Note November, 2006 Sustainable Development Department South East Europe Country Unit Europe and Central Asia Region Page 2 ii CURRENCY AND EQUIVALENT UNITS (as of November, 2006) Currency Unit = MKD US$ 1 = MKD 48 ABBREVIATIONS ADKOM Association of Municipal Communal Enterprises MLSG Ministry of Local Self- Government BEEPS Business Environment and Enterprise Performance Surveys MOA Ministry of Agriculture CSE Communal Service Enterprise MOTC Ministry of Transport and Communications DUP Detailed Urban Plan MOF Ministry of Finance EAR European Agency for Reconstruction OECD Organization for Economic Cooperation and Development EBRD European Bank for Reconstruction and Development PIT Personal Income Tax ECA Europe and Central Asia region PLC Public Limited Company EU European Union PRO Public Revenue Office FYR Former Yugoslav Republic PSP Private Sector Participation GDP Gross Domestic Product SEE South East Europe GUP General Urban Plans SNG Saur Neptun Gdansk GTZ German Agency for Technical Cooperation SSO State Statistical Office HBS Household budget survey UNDP United Nations Development Programme KFW Bank for Reconstruction (Germany) UPU Urban planning unit LED SP Local Economic Development Strategic Planning USAID U.S. Agency for International Development LFS Labor force survey VAT Value-Added Tax MKD Macedonian dinar ZELS Macedonian Association of Local Self-Governments Vice President : Shigeo Katsu Country Director : Orsalia Kalantzopoulos Sector Director : Peter Thomson Sector Manager : Sumter Lee Travers Task Leader : Christine Kessides Page 3 ACKNOWLEDGEMENTS The present report is intended t o contribute to the Bank’s dialogue with the Government of FYR Macedonia and with municipal governments on urban and local governance issues, and to provide analytical background to the Bank’s ongoing assistance program. The study draws on existing published and unpublished material and on two missions, in December 2005 and May 2006, which provided interviews with central and local government officials, donors, and other stakeholders including professional associations and communal service enterprises. The missions visited the municipalities of Gostivar, Kocani, Mavrovo-Rostusa, Struga, Strumica and Veles, and interviewed the mayor of Vasilevo. The study team was led by Christine Kessides and comprised Jan Brzeski (urban planning and land management), Maha Armaly, Bekim Imeri, and Stefan Rattensperger (decentralization, municipal financing, communal services enterprises). Jasminka Sopova assisted the mission in the field and Rozena Serrano provided support in document production. Page 4 CONTENTS EXECUTIVE SUMMARY...............................................................................................vii 1. The current context of urban and municipal development.............................................1 A. INTRODUCTION AND BACKGROUND ..........................................................................1 B. A FRAGILE RETURN TO GROWTH ..............................................................................1 C. T HE D EMOGRAPHIC C URRENTS ................................................................................5 D. P OVERTY HAS APPEARED INTRACTABLE , ESPECIALLY IN URBAN AREAS ..................7 E. D ECENTRALIZATION HAS GIVEN MUNICIPALITIES GREATER RESPONSIBILITIES .......12 F. EU C ANDIDACY CREATES ADDED MOMENTUM ......................................................13 G. C ONCLUSIONS ........................................................................................................13 2. Municipal financial management and capacity-building .............................................15 A. T HE EVOLUTION OF THE POST - DECENTRALIZATION MUNICIPAL REVENUES ...........15 B. T HE STRUCTURE AND FUNDING OF LOCAL GOVERNMENT EXPENDITURES ...............20 C. C OMPARISON OF PROJECTED FINANCIAL CAPACITY ACROSS MUNICIPALITIES .........21 D. M AIN ISSUES OF MUNICIPAL FINANCIAL MANAGEMENT ..........................................23 E. S TRENGTHENING INSTITUTIONAL PERFORMANCE ...................................................30 F. C ONCLUSIONS ........................................................................................................33 3. Communal Services......................................................................................................35 A. T HE STATUS OF LOCAL INFRASTRUCTURE SERVICES ...............................................35 B. L EGAL AND INSTITUTIONAL ISSUES IN THE COMMUNAL SERVICES SECTOR .............37 C. M AJOR FINANCIAL ISSUES AFFECTING THE COMMUNAL SERVICE ENTERPRISES ......40 D. C ONCLUSION ..........................................................................................................44 4. Urban planning and land management.........................................................................46 A. I NTRODUCTION .......................................................................................................46 B. U RBAN P LANNING AND U RBAN D EVELOPMENT ....................................................47 C. U RBAN L AND M ANAGEMENT .................................................................................51 D. C ONCLUSIONS ........................................................................................................62 REFERENCES..................................................................................................................74 IBRD MAP 35041 ANNEX Annex 1- Public or/ Private Management of Municipal Utilities Issues, Options and Examples...........................................................................................................................63 STATISTICAL APPENDIX Figure A1.1 Rural- Urban Poverty Convergence…only in FYR Macedonia...................71 Table A1.1 The poor have limited access to the labor market:........................................72 Table A1.2 Vulnerability to poverty in 2004 (in %)........................................................72 Table A1.3 Formal non-agricultural labor income has helped the rural poor:.................73 TABLES Page 5 ii Table 1-1: Recent Economic Indicators.............................................................................3 Table 1-2: Poverty Status by Urban-Rural Location in Western Balkans .........................8 Table 1-3: Consumption Poverty Rates by area, 2002-2004 .............................................9 Table 2-1: Structure of Municipal Government Revenues, in thousand MKD. ..............17 Table 2-2 Selected per capita municipal finance indicators, 2006 projections................22 Table 2-3: Property tax in transition countries.................................................................24 Table 3-1 In-dwelling connections to infrastructure (percent of population)..................35 Table 3-2: Infrastructure Coverage in Major Cities in Macedonia..................................37 FIGURES Figure 1-1 FYROM has resumed a growth path, but below that of its neighbors.............2 Figure 1-2: Population is dispersed among mainly small municipalities...........................7 Figure 2-1: Structure of municipal expenditures, in thousand MKD................................21 BOXES Box 1-1: How local stakeholders perceive their economic and social development priorities ..............................................................................................................................5 Box 1-2 Conditions in substandard settlements...............................................................11 Box 1-3 The evolving legal framework for decentralization............................................13 Box 2-1 The current practice of municipal collaboration in FYROM..............................33 Box 4-1 Municipal land leaseholds (perpetual unsufruct) in Poland...............................58 Page 6 i Unlocking the Potential of Urban and Municipal Development in FYR Macedonia Main messages of the report: · Positive achievements and persistent problems point to the need for more effective urban and municipal management. · Decentralization is the beginning of new governmental relationships · Municipalities will need continued support from central government, and from each other. · Coordination should be both vertical (between central-local levels of government) and horizontal (among local governments). · Capable and responsive local government also requires accountability to citizens. · The quality of life and productivity of urban areas also depends critically on the performance of communal services enterprises · These municipal-owned enterprises control the life-blood of the cities. · Pervasive institutional issues and financial weaknesses point to a challenging agenda for reform. · Urban planning and land management guide the use of a major urban asset--land · Planning provides structure for the urban marketplace. · Government —central and local—could become a more helpful participant in urban land management. · To conclude, Macedonia must greater advantage of the economic potential of its cities. Page 7 ii Summary of the report’s findings: Positive achievements…. In the past couple of years Macedonia has entered a phase of strong economic growth (4 percent annually). It has completed the design and legislative framework for an extensive process of decentralization, which was launched formally in mid-2005. And the country has won the status of candidate for EU accession. These hard-earned gains deserve much credit. But to realize fully the benefits and sustain the growth, many difficult challenges remain in strengthening the economies and public management at the local level —particularly in the cities. …and persistent problems… In all countries the larger and more complex urban areas — cities—tend to be the locations for new enterprise creation, trade, and economic diversification, especially into higher-value manufacturing and services. In this way cities host a growing labor market with a wide range of employment opportunities. But in Macedonia the private enterprise sector remains immature and dormant. Unemployment continues to linger around 35 percent, well above rates in neighboring countries. And the numbers of poor people (those falling below a threshold level of consumption) in urban areas have been increasing, now exceeding those living in rural areas. This is particularly puzzling since in most countries (including elsewhere in South East Europe), urban poverty rates are typically the lowest because cities offer better access to jobs and services. …point to the need for more effective urban and municipal management. These conflicting trends indicate that the urban economies are not performing as well as they should to serve thei r residents or the country at large. The World Bank’s recent Urban Policy Note looks at a range of issues in how cities are being managed. The municipalities have been given important new authorities and resources, and they face major responsibilities as the front-line forces confronting the country’s current social and economic challenges—but they cannot succeed without strong and continued support from the central government. The report focuses on the policy agenda in three areas— municipal financial management, the provision of communal services, and the planning and management of urban land use—that will be key to Macedonia’s success in sustaining economic growth, improving welfare for all citizens, and furthering integration into the European region. Decentralization is the beginning of new governmental relationships Municipalities will need continued support from central government, and from each other. From July 2005 the 84 municipal governments acquired a significant increase of autonomy in raising revenues and delivering local services. This fiscal and administrative decentralization was intended not only to make government more responsive to the needs of households and firms at the local level, but also to fulfill the promises of the Ohrid agreement in promoting national harmony, as well as bring the country closer to the practices of the European Union in anticipation of eventual membership. These are very challenging goals. Success in meeting them and satisfying Page 8 iii the expectations of constituents will require more than the evident commitment and enthusiasm of the local authorities. Experience in many other countries that have implemented similar decentralization program points to several lessons of relevance to Macedonia at the present juncture. Coordination should be both vertical (between central-local levels of government)…. The first message is the importance of ensuring effective coordination across levels of government. There is a continuing need for leadership and support by central government, which sets the regulatory and legal conditions for the municipalities. For example, one of the local taxes with large revenue potential is the annual property tax —yet the extensive exemption of commercial property, which is almost unprecedented internationally, imposes a severe constraint on municipal revenue gains, an issue that only central government can address. The central government should also help ensure that the municipalities acquire and retain a secure financial status, by keeping fiscal transfers predictable and formula-based, and by making capital funding (such as from the road fund) contingent on sound investment planning. Such measures will become increasingly important to bring the local governments into position to use EU structural funds when they become available. The municipalities also require the strategic guidance of central government in defining the options for local economic development, such as in the promotion of tourism and management of cultural heritage sites and natural resources, conditions for attracting private investment, and development of construction land (discussed further below). and horizontal (among local governments). In many countries municipalities have found mutual benefit in forging voluntary forms of cooperation to perform their mandated functions effectively while reducing costs—whether for administrative tasks such as tax collection, or managing infrastructure facilities such as water supply systems and landfills. These arrangements can be especially advantageous for small municipalities. Several interesting experiments with such collaboration have already begun in Macedonia, and it will be useful for the municipalities to share the experiences as well as look to similar such examples elsewhere in the region. Capable and responsive local government also requires accountability to citizens. Decentralization in other countries offers a second lesson: that to ensure better local government it is necessary not only to train the municipal officials but, just as importantly, to open the processes of government to the public and to examine its performance through regular monitoring. Many donors have been providing Macedonian municipal authorities and their staff training in government functions such as planning and budgeting. Some externally-funded projects have introduced features of public participation in investment selection. But municipalities typically do not promote the two-way flow information—making citizens aware, and communicating their needs and views back to government—that is essential to good governance. The central government can encourage this behavior as well, along with ZELS, by assisting the collection and monitoring of data on municipal performance. Many countries have found that making such information publicly available for comparison among municipalities, or Page 9 iv with reference to benchmarks of good performance, can create the impetus for needed improvements. The quality of life and productivity of urban areas also depends critically on the performance of communal services enterprises These municipal-owned enterprises control the life-blood of the cities. Local infrastructure services, particularly water and sanitation, solid waste management, and public transport, are among the most important responsibilities of local government. They contribute directly and indirectly to economic growth, household welfare, and environmental sustainability. Most of the communal services were relatively well- developed in Macedonia at the time of transition, except for solid waste management and household heating. But overall they have suffered in the last decade and a half from neglected maintenance, rigid tariff control, and poor financial management, leading to a vicious cycle of deterioration in assets and services, and a lack of funding for new investments. These problems threaten the ability of the communal services enterprises to upgrade or even sustain services, to support competitive business, and to improve the welfare of residents in substandard settlements —let alone to meet the standards of EU accession. Pervasive institutional issues and financial weaknesses … The legislative and regulatory framework for communal services does not sufficiently promote commercially oriented behavior by the utilities. There is evidence of local political influence in the staffing and management of the enterprises. The financial health of many of the enterprises is weakened by years of tariff restrictions imposed by the central government, which were only recently removed —currently, in most of the municipalities, water tariffs are about 50-75 percent lower than the estimated level required to achieve cost recovery. Water losses—water produced and not billed—average about 40-50 percent, very high by international good practice standards. And the rate of collection on billed water is equally low, about 50 percent. Therefore, the utilities are far from realizing their revenue potential and have been accumulating debts and arrears—which could also become contingent liabilities for the owner-municipalities. The overall result is a worsening backlog of capital repairs, replacement of aging equipment, and investments to improve and expand systems. …point to a challenging agenda for reform. The national and municipal governments, together with ADKOM and the user community, need to work together to support a program of actions to restore the health of the communal services sector, by: · Creating strong incentives for improved financial and operational performance — these should include separating political from operational decisions on employment and tariffs, improving collections, and prioritizing maintenance and equipment expenditures to reduce water losses and reduce costs. · Further promoting commercial orientation and financial transparency by separating the accounting of tariff-based services (such as water supply) from non-tariff based activities (such as park maintenance), when both are done by the same enterprise, and providing separate tax funding for the latter. Similarly, Page 10 v rather than dictating general limits on tariffs, the central government should work with the municipalities to provide compensation to the households unable to afford the commercial rate for basic consumption. · Monitoring and making publicly available information on the quality of services and performance by enterprises. ADKOM has already started gathering such basic performance data on communal services. Further, there is need for public information campaigns on the importance of payment discipline, to permit investments that would improve outcomes for users. Such measures are preconditions for the enterprises and municipalities to take advantage of future EU funding for new investments, which are a particular priority in wastewater treatment and for proper waste disposal. Private sector participation in the financing and operation of communal services will also become a practical option only after the preconditions are in place for a commercially sound management and tariff structure. Urban planning and land management guide the use of a major urban asset--land Planning provides structure for the urban marketplace. At its best, urban planning enables real estate markets to assess investment risks and reduces uncertainty about potential gains, while protecting the public interest in urban land uses. Macedonia, like all other transition countries, faces a difficult challenge to forge a new path between the past tendencies of overdirection and control, on the one hand, and a flexible, market- friendly but enforceable style of urban planning. While progress is well underway in updating the land registration and cadastre, the country has only begun to think about reforming urban planning, which is still characterized by technocratic, architecturally- oriented designs that are quickly outdated. In order to meet the legal requirements for general and detailed urban plans that can permit an adequate development of land to meet the demands for housing and commercial properties, while preserving amenities such as green space, municipalities together with central government will need to approach urban planning differently than in the past. First, both the local authorities and the professional planners need to think increasingly in terms of the market. A basic requirement will be to collect and incorporate regular data on real estate market trends, and demand and supply factors — information that is best assembled by central government at least initially, as a public good for all parties. Second, broad participation of citizens and private firms is essential early on in the urban planning process, to mobilize information on trends and preferences and to garner consensus on the eventual choices to be made. Third, there is scope to streamline the planning process, including by reducing unnecessary procedures and clearances, to ensure that the plans are timely and relevant to evolving market circumstances. Government —central and local—could become a more helpful participant in urban land management. Public sector interventions can help implement urban planning goals by making land available for the market and facilitating uses of land for public purposes. In addition to ensuring a well-functioning registration and cadastre process, and assisting public access to market information as noted, governments have an essential role in Page 11 vi servicing land through infrastructure investments. There may be an issue in some municipalities with the construction impact fees payable with the application for building permits; in some cases these fees appear excessive, raising the costs of legal land development unduly and encouraging illegal construction. The apparent imbalance between the high construction impact fees and absence of business property taxation should be reexamined, as it is likely to distort incentives for land use and curb the supply of serviced land to the urban market. Municipalities have already initiated steps to make the construction permitting process simpler and more efficient. Many cities have a lingering problem of settlements without legal status or adequate services, where the problems for households may include low ability to pay and absence of tenure security. In these cases central and local governments will need to explore together medium-term solutions to regularize and integrate these areas into the urban network. As is common practice in market economies, the municipal governments could also become direct participants in land transactions in their locality, to pursue economic, financial and environmental objectives. Currently the municipalities in Macedonia are not permitted to own land and can only request the central government to auction State owned properties when there is a private investment interest, but do not participate in such decisions administratively or financially. As an interim solution or complement to eventual municipal land ownership, the State should consider granting secure long-term leaseholds to municipalities, with conditions that the use of land, if developed by the municipality or transferred to a private investor, conforms to the urban plan. Such arrangements, as common in Poland, for example, can avoid speculation and free land for active investors, while returning a source of income to the municipality. To conclude, Macedonia must greater advantage of the economic potential of its cities. Meeting this challenge will require central and municipal governments to work together with citizens and the private sector in the new decentralized environment. They can satisfy the growing demands for local infrastructure services, and for land development, in a manner that is affordable to users and both financially and environmentally sustainable. This agenda will help Macedonia achieve continued growth for the benefit of all its citizens, and continued integration into the regional economic community. Page 12 vii EXECUTIVE SUMMARY The evolving context for urban and municipal policy The present study examines the challenges facing municipal governments in FYR Macedonia —with a particular focus on municipal finances, delivery of communal infrastructure services, urban planning and land use management, in secondary cities. There are several reasons why a policy note on this subject appears timely. First, while the national economy has returned to a solid growth path in the past few years, ensuring continued recovery and tackling persistent problem areas, such as unemployment, will require exacting a better performance from the cities, which are invariably the platforms for economic diversification, private investment and enterprise creation. Second, the urban population and urbanization rate continue to increase, as expected for a country undergoing economic development and aspiring to the European norms. Third, poverty has proven particularly tenacious in urban areas despite the wider opportunities normally found there. Fourth, the political and fiscal decentralization launched in 2005 has conferred new responsibilities and new resources on local governments, creating high expectations and increased demands on the part of constituencies. Finally, FYR Macedonia’s recently-won status as an EU candidate raises the stakes further for good local governance and resource management. Many economic issues and accomplishments have urban roots. Economic growth has resumed an upward trend, averaging about 4 percent in 2004 and 2005. While the country’s growth rate is respectable it is still below that of most of its neighbors in South East Europe. All economic sectors have contributed to the recovery, albeit erratically. The services sector, which has developed since the transition, is highly concentrated in the region and city of Skopje. The economy suffers from a number of thorny structural problems—especially persistent unemployment. While many of the old public enterprises have closed, fewer new establishments have appeared in their place to provide significant job growth, and the domestic private sector is still small. Recent business surveys identify several problem areas (including contract violations, anti-competitive practices, crime and corruption, financing, electricity and telecommunications) where the economy ranks below that of ECA neighbors and especially, the core EU countries. Some of the issues hampering enterprises may be rooted at the municipal level. Participants of strategic planning exercises in numerous municipalities in the last couple of years point to priorities for reform: provision of better infrastructure, more responsive and professional municipal administration, and a vibrant entrepreneurial sector. The urban demography is changing. Continued urbanization can be expected as part of the normal economic development process. It is projected that the urban share of population will rise from the present rate of about 65 percent to about 78 percent in 2020 (UN, 2006), which would bring it close to the EU average. Most of the urban population is distributed across quite small municipalities, typically lacking experienced staff. The demographic outcomes between the last censuses (1994 and 2002) reveal a trend of Page 13 viii increased household creation and a rapidly aging population. The former creates continued pressure on housing supply, while the latter implies growing need for social services, as well as employment for the working age group that must support the elderly. Municipal governments will be on the front lines to address all of these demands. Urban poverty is a growing and stubborn problem. FYR Macedonia is distinguished within its subregion in the patterns and persistence of consumption poverty, which has hovered around 21 percent through 2002-2004. Unlike most of its neighbors it experienced an increase in the numbers of poor people in urban areas, significantly exceeding those in rural areas, in the last year surveyed. Unemployment rates are also higher among the urban poor (particularly for certain ethnicities) than for the rural poor. Urban poverty incidence is usually much lower than rural because cities offer deeper labor markets and easier access to services and formal safety nets. So the unusual poverty picture in Macedonia suggests real dysfunction in the urban economies. Yet they provide the major sources of household income through formal nonagricultural activities, even for the rural population, as well as private transfers. Urban economies therefore hold great importance for both urban and rural residents, through widening opportunities and resource exchanges. The formal poverty data do not take much account of non-monetary poverty, which is determined by the quality and affordability of housing and essential services. “Housing poverty” is estimated to affect 7 percent of the population, enough to raise the effective poverty rate by one-third. The poverty surveys also do not fully account for residents of substandard settlements—areas developed without title or building permits. These settlements, affecting about 11 percent of the residents of the largest cities, face more serious shortcomings in water supply, wastewater and solid waste collection and disposal, and household energy, as well as unemployment. Ensuring that all residents have full access to the institutions and opportunities of the city is a key challenge at the doorstep of the municipal governments. Decentralization and the prospect of EU accession create new opportunities, responsibilities, and pressures for municipalities. In 2005 FYR Macedonia began formally implementing an extensive decentralization process as agreed under the Ohrid peace agreement in 2001 that ended a period of interethnic conflict. Thus decentralization was intended not only to promote resource allocation efficiency and accountability, but national harmony as well. So far the process appears to have been implemented fairly smoothly, given its rapidity. Clearly there are greater capacity constraints at the outset in the relatively “new” and smaller municipalities (about 50), compared to the 34 “core” municipalities that had functioned as such prior to the latest territorial reorganization. Experiences of decentralization in other countries indicate that realizing the benefits of decentralization requires attention to ensuring: a) continued intergovernmental coordination, with guidance and support from central government; b) inter-municipal cooperation; c) adequate capacity of the local authorities; d) measures to establish accountability to constituents (which is not guaranteed without effort); and e) monitoring of local government performance. Page 14 ix In this early stage of decentralization in FYR Macedonia some issues have revealed themselves, where problems of poor intergovernmental communication or insufficient leadership from the center have created tensions and difficulties in local governments. One of these issues regards inadequate sharing by national agencies of certain information municipalities require, notably regarding property taxation. A second concern is the apparently slow ministerial responses to municipal needs for sales of state land. Third, there appears to be a lack of guidance from central government regarding some key national policies and institutional frameworks that affect the scope for municipal action —for example, regarding public-private partnerships, and strategies for developing tourism or other activities with implications for local economic development. FYR Macedonia’s candidacy for the EU underscores the need for full collaboration, horizontal and vertical, across units of government, to take advantage of opportunities for new investment and their related requirements. After decentralization: municipal financial management and capacity building Local budgets are being transformed . The decentralization launched in July 2005 has given municipalities new authority to collect and retain locally raised revenues and to set their level (within a specified range), including property tax, various charges and fees. While it is too early to identify trends before and after decentralization, projected municipal budgets for 2006 confirm a dramatic increase in all local government revenue sources—from a total of MKD 4-5 billion (US$100 million) to MKD 11 billion (US$238 million). Locally raised tax revenues are projected to increase by about 70 percent over their 2003-04 levels, although they will decline in percent of the total because transfers (including for maintenance of schools and social services) will almost triple. Macedonian local governments appear to expect an unusually high reliance on “own sources of revenue,” relative to other countries in the region. However, total local government revenues remain very small in relation to GDP (estimated at 3.8 percent), because municipal budgets do not yet cover all operating (salary) costs of education and social institutions. Many of the municipalities are expected to rely increasingly on property-related taxes, such as the tax on real estate transfers, and on the construction impact fee. It should be noted that these sources are unpredictable and unequally available, they naturally produce much higher revenue in Skopje than elsewhere. With the combined effect of transfers and the distribution of VAT and PIT shares, the 2006 projections indicate considerable equalization of overall revenues and capital funding available across the secondary and tertiary municipalities—particularly aiding the smaller ones. In fact, cities with over 50,000 inhabitants may end up the most disadvantaged (on a per capita basis), especially in terms of capital transfers, if the budget projections available as of mid-2006 hold. On the expenditure side, decentralization will have the greatest impact on operating budgets, which increase almost threefold with the new responsibility assignments to municipalities. Most local investment in 2006 is expected to be funded from own revenues, which clearly poses a challenge to inexperienced municipalities. Page 15 x Many areas of municipal policy still need attention. Several issues require continued attention to ensure that the decentralization is successful in promoting a sustainable revenue base, effective investments, and good local governance: (i) Property taxation . Administration of all three property-related taxes (the recurrent annual tax, transfer tax, and gift and inheritance tax) has been devolved to municipalities. While this provides an incentive for them to make a major mobilization effort, the municipalities require the full cooperation of the central Public Revenue Office and depend on information from the land registration office (being modernized and updated under a current Bank project). In 2005/06 there were significant delays and transactions costs in the handover of information from the PRO to the municipal governments, although the situation is apparently getting resolved. Municipalities can greatly improve revenues from the annual property tax (projected for 2006 as 3.4 percent of their local revenues, a negligible share of GDP) by taking action to: (a) more effectively collect the tax owed (ensure greater compliance), (b) improve records of taxable properties, (c) update the tax assessments, and (d) increase rates from their very low levels, within the allowed range. But the most important reform, which lies beyond municipal control, is to reduce the vast exemptions provided in the law —and especially to remove the unusual exemption for business property. It should be recognized that property taxation is politically charged for local governments and has been difficult to implement in most middle-income countries, so real progress will take time and proactive leadership by central government. (ii) Municipal debt . The large debts inherited by some municipalities from the previous administrations (prior to decentralization) remain a sensitive topic, particularly in the cases of municipal mergers. The national government has established a firm and correct position against bail-outs, and the new fiscal law preempts renewed local borrowing until good financial performance has been demonstrated (not earlier than end- 2007). Since most of the old debts are owed to a single major construction company (formerly a public sector enterprise), some of the smaller municipalities may require assistance in negotiating feasible repayment terms. Ultimately, ensuring that municipalities retain a healthy balance sheet will depend on policies in two areas discussed further below: (a) their ability to participate financially in sales of construction land and to manage land and real estate assets in their jurisdiction, and (b) reforms in the financial management of communal service enterprises that the municipalities own. (iii) Investment planning and selection. Despite their expectations of increased autonomy, municipalities continue to rely heavily on certain central investment grants, especially for road and water related investments. This investment selection process does not appear to be based on strategic prioritization or to encourage sound investment evaluation. Therefore, municipalities have limited incentives for, and little experience in, undertaking multiyear investment planning. Improving this process will be important as FYR Macedonia undertakes to use the structural funds forthcoming from the EU, and to anticipate the necessary counterpart resources. (iv) Cooperation and association among municipalities . Small municipalities may only be able to undertake the full array of administrative responsibilities by sharing Page 16 xi efforts with others, to exploit economies of scale and compensate for limited staff and facilities. Collaboration in services of tax collection and building inspection is starting in several cases, and this experience should be shared for the benefit of other municipalities. Greater exposure to international good practices in inter-municipal collaboration may also help demonstrate the efficiencies that can be gained and overcome possible local resistance. (v) Performance monitoring . The Ministry of Local Self Government, with donor support, is collecting data on municipal activities with the aim of ensuring implementation of the decentralized framework. The efforts would be helped by a more readily-available breakdown of statistics from central government agencies. Although public comparisons of the performance of local governments is considered politically sensitive in Macedonia, it is important that monitoring be seen as a necessary element of good governance and essential to an informed electorate, as well as to informed policy makers and service operators. Citizen surveys and other opportunities for constituents to rate or give feedback on municipal performance can promote improved accountability by local government. Wide access to information on municipal activities, such as through published budgets, can also be an important tool to combat corruption. Monitoring should encompass not only the formal implementation of laws and regulations, but also analysis of outcomes and impacts of policies and practices. For example, it would be useful for the central government to assess (or to sponsor assessment by a third party, such as a university) the collection efficiencies of certain types of local taxes, the potential tax capacity versus actual tax collections, and indicators of operational efficiency in the delivery of municipal services. A comparison with other middle-income countries and the EU on the level of property taxation and on per capita local revenues and expenditures, for example, would provide national and local policy makers with benchmarks or targets for municipal performance. (vi) Training and capacity building . Macedonia has a long tradition in local government management and service delivery, stemming from the Yugoslav era. But specific skills and experience were lost during the recentralization of the last decade, and attitudes establishing trust and transparency, and public participation in governance, remain weak. Capacity needs to be redeveloped focusing on the newly transferred competencies, and developing practical solutions for service provision especially in the smaller/newer/poorly resourced municipalities. Many donors, including the Bank, have been providing training, technical assistance and equipment to most of the municipalities. As a result they are quite aware of desirable management approaches and tools, but they have little practice and limited staff. A key gap is assistance in applying and implementing many of the methods taught and ensuring incentives for accountability to the public. Page 17 xii The Communal Services Enterprises Local infrastructure services, for particularly water and sanitation, solid waste management, and public transport, are among the most important responsibilities of local governments as they contribute directly and indirectly to economic growth, household welfare, and environmental sustainability. Most such “communal services” in FYR Macedonia were relatively well-developed at the time of transition but have suffered in the last decade and a half from neglected maintenance, rigid price control, and poor financial management, leading to a vicious cycle of further deterioration of assets and lack of funding for new investments. Data are not readily available on the status of infrastructure sectors in FYR Macedonia, relative to other countries in the region. Simple access to network connections does not appear to be a large issue overall 1 , even for the poor, although there has been little analysis of quality and affordability of services. But the institutional and financial issues are more easily identified. They generate little confidence in the ability of the enterprises to upgrade or even to sustain a good level of service, especially to support the needs of competitive business and to improve the welfare of substandard settlements, let alone to meet the standards of EU accession. Fundamental legal and institutional issues … In FYR Macedonia local public services, including water supply and sanitation, urban transit, as well as street cleaning and operation of parks, marketplaces, cemeteries, and so on, are provided through municipally-owned enterprises —in most cases a single multipurpose entity, although a few municipalities have separate water utilities. Communal service enterprises are legally independent from their municipal owners; however, in practice there does not seem to be an arms-length relationship. The multipurpose enterprises entail extensive cross-subsidies, blurring the commercial orientation of tariff-based services such as water, while public good-type services such as park maintenance should be funded by general taxes. The combined operation of such diverse services in a single enterprise can be an efficient solution especially for small municipalities, provided there is a strict accounting separation between revenue-earning and non-revenue-earning activities. The legislative and regulatory frameworks pertaining to communal services, although recently revised (most laws are newly enacted since 2002), remain weak and contradictory in several respects, and thus do not effectively promote independent, commercially oriented utilities. Although the laws provide a formal distinction between the finances of the communal services enterprises and those of the municipality, practices do not appear entirely consistent with this principle. Financial reports are not widely available, even though the Association of Municipal Communal Enterprises (ADKOM) and the Association of Financial Officers have started collecting basic indicators on enterprise efficiency and financial performance for a considerable number of enterprises. Given the environment of management incentives, it is not surprising that over 1 There are larger issues in household energy (district heating is very rare outside two cities), wastewater treatment (almost nonexistent), and solid waste disposal (sanitary landfills limited to Skopje). Page 18 xiii employment remains a problem in the communal enterprises, as well as political influences in the staffing structure. …and pervasive financial problems. Numerous and persistent financial problems in many of the communal services enterprises are mutually reinforcing and linked with the institutional framework issues. Water losses are very high (40-50 percent of water produced on average), reflecting a combination of managerial and technical inadequacies. Collection rates are extremely low (about 50 percent of billings). Although the new legislation permits cutoff for nonpayment, the discipline does not seem widely applied. The tariff regime has been inflexible —only in 2005 the national government lifted a decade-long moratorium on water tariff increases. Tariffs still need considerable adjustment. Outside the few utilities receiving EBRD loans, current water tariffs are 50- 75 percent lower than an estimated cost recovery benchmark. Many communal services enterprises carry persistent arrears, mainly because of non- payments by other public entities. Antiquated accounting rules prevent the utilities from clearing their books of these old debts in accordance with good commercial practice. At the same time, the communal services enterprises themselves appear to be accumulating debts, especially short term, to finance their own operations, while few acquire long term loans for investment. In general, incomplete and obscure reporting of the enterprise financial situations is a concern, especially as the municipalities can become implicated through contingent liabilities as owners. An obvious result of the weak financial situation of communal services enterprises is a growing backlog of maintenance and investment requirements. The vehicle and equipment fleet is aged. Investment funds available from the MOTC are only adequate for routine capital repairs and minor system expansions. While prospective EU funding should help meet the large needs for new investments, e.g., in wastewater treatment, mobilizing the counterpart financing will require disciplined effort and reforms from both the enterprises and their municipalities. It will be useful for all of the stakeholders to seriously considering the potential benefits of private sector participation (PSP) in the provision of communal services. A basic precondition would be for government at all levels to commit clearly to a commercial orientation for the sector. …suggest a challenging agenda for sectoral reform. It is suggested that the national and local governments, together with the professional associations of municipalities and communal services enterprises and the user community, should work together to support the following actions: (i) Create strong incentives for communal services enterprises and local governments to improve their financial performance. A first priority would be to separate political from operational decisions of the enterprise, particularly on employment and tariff collections, and to provide a clear accounting separation among diverse enterprise activities. Performance conditions could also be built into the criteria for central government grants to enterprise investments. Page 19 xiv (ii) Improve operational efficiencies and curb increases in the costs of water production by: (a) improving collections; and (b) taking measures (including priority capital expenditures) to minimize water losses and procure updated equipment. (iii) Encourage municipalities and their communal services enterprises to collaborate across municipal boundaries to achieve potential economies of scale and other efficiencies in the delivery of services. (iv) Support ADK OM’s efforts to maintain and expand the database of indicators on the performance of communal services enterprises—including monitoring of their debts—and publicize the analysis as a means to compare the quality and efficiency of communal services and encourage good practices. (v) Increase public accountability of communal services enterprises to their users— this will require both providing the public more information on the enterprise performance, cost and quality of services, as well as creating opportunities for users to give feedback and register complaints. (vi) Increase positive participation and information campaigns with citizens on the need for discipline in fee payments and for cost recovery to permit investments that would improve the local quality of life, as well as meet EU standards. Part of this public dialogue should focus on the potential benefits to be gained from involving the private sector in provision of services, within a framework of strong public oversight and transparent, competitive awarding of contracts. The financial improvements outlined above are necessary preconditions for attracting any significant private sector funding of the communal services sectors. Urban planning and land management Planning can provide structure for the urban marketplace … When done well, urban planning enables real estate markets to assess investment risks and reduces uncertainty by setting transparent rules, while enabling the government to protect public interest. FYR Macedonia, like all other transition countries, faces a difficult challenge to forge a new path between the past tendencies of overdirection and control, on the one hand, and a flexible, market-friendly but enforceable style of urban planning. While progress is well underway in updating the land registration and cadastre, the country has only begun to think about reforming urban planning, which is still characterized by technocratic, architecturally-oriented designs that are quickly outdated. The local governments in FYR Macedonia are legally required to produce 10-year general urban plans (GUPs) and (at least in the larger jurisdictions) detailed 5-year urban plans (DUPs). Based on best practice in market economies and to remain relevant to the rapidly changing urban economies, the local planning efforts should aim to identify: (a) overall goals and socio-economic vision for the city development, (b) clear land use Page 20 xv criteria, (c) zones for restricted development (e.g. respecting environmentally and historically sensitive sites), and (d) reserved rights of way for major roads and infrastructure. Such plans should also specify land use regulations (such as allowable building heights) to guide private investment. It is essential that the plan and regulations incorporate a realistic assessment of real estate trends, demand and supply factors, to accommodate the underlying market tendencies and ensure that housing and other real estate remains affordable to businesses and to households. Introducing such planning in FYR Macedonia is hampered by a shortage of suitably re- oriented planners who understand the requirements of a market economy. While several donors are providing basic training for municipal staff and helping them develop tools and information sources to facilitate better planning, the needed “paradigm shift” will take time for them and for the planning professionals. Just as important is reform in the process of implementing urban plans and regulations. The government procedures for approving the GUPs and DUPs need to be streamlined, to cut down on unnecessary requirements (thus reducing the scope of work for planners) and shorten the turnaround time. Public participation is currently treated in an ex post fashion and there is little direct consensus building with other stakeholders. The law on urban and spatial planning, revised in 2005, does not necessarily preclude these reforms but it will need to be implemented with a spirit of facilitating a more flexible, agile and market-friendly process. …and government can become a helpful participant in urban land management. Public sector interventions of urban land management should aim to implement the goals of urban planning and support the land market, by dampening investment risks and costs, reducing negative externalities from incompatible land uses, and providing necessary public space and amenities. Land management instruments or activities are of several types: a) registration and cadastres, b) market information and monitoring, c) servicing land through infrastructure investment, d) increasing the supply of land on the market, e) construction permitting and building inspection, and f) property taxation. Not all of these have been fully decentralized to municipalities, and they should not be undertaken all at once. The first three elements may be considered “absolute” priorities, because they underpin other land management options, both public and private. Within each category there are political and technical issues that will affect the appropriate sequencing. Substantial reform and institutional development are most advanced on registration and cadastre upgrading—while market monitoring and infrastructure investment in land servicing seem to be lagging and call for more committed attention by government. Reforms are also underway in construction permitting and building inspection. Property taxation has commanded attention from the local governments but faces many hurdles requiring central government cooperation, as discussed previously. In each policy area there are outstanding issues and potential opportunities that merit government consideration: (i) Land registration and cadastre. Completing the process is essential to clarify property rights (for subsequent reallocation through the market), and to permit integration Page 21 xvi of physical, legal and fiscal data for urban management and local governance. A database to monitor current transactions is needed as well (below). (ii) Market information and monitoring. Both public and private land decisions require knowledge of the “value structure” of properties and factors impacting market prices and costs. Reliable market monitoring should be viewed as an “information infrastructure” responsibility of the public sector as long as the private sector does not find it financially viable to deliver, and should be made publicly available. A central agency may need to take on this function since municipalities are little inclined and ill equipped to do so. (iii) Infrastructure investment . Progress in this area will depend to some degree on reforms of the municipal utilities and potential opening to private sector participation as discussed above, and on continued improvements in own revenue mobilization to (re)establish creditworthiness. The municipalities’ capacity to finance infrastructure investment could be enhanced by giving them a share in the proceeds of state land sales in their area and by more strategic management of their own real estate assets. (iv) Increasing land supply. As in other transition countries, economic recovery and growth in FYR Macedonia will raise the demand for residential real estate, pressuring prices and affordability unless land supply and housing production respond adequately. Currently state land dominates the city centers and can be accessed through tendered sales and leaseholds. Municipalities are not allowed to own land in their area. They can request the state (MOTC) to sell land to interested investors or can obtain leaseholds themselves, but they do not participate financially or otherwise in these transactions. The process of releasing state land to the market is said to be cumbersome and protracted. Municipalities should be allowed to own land as is the usual practice in other middle-income and transition countries, but at minimum they should be encouraged to manage land through active involvement in decisions about public land sales. A productive alternative and political compromise in the near term could be for the state to grant secure long-term land leaseholds to municipalities on specified conditions, such as having an updated DUP. The municipalities should then be permitted to divest the leasehold to private investors on further conditions, such as compliance with the plan and commitment to complete the investment in a specified period. Such leaseholds (perpetual usufruct) would be attractive to capital-short investors, but could also be converted later to freehold. Providing long term leaseholds would give the municipalities an effective instrument to influence the market and land use, discourage land speculation, and provide a stable, asset-backed source of income. Urban land supply also requires better resolution to problems of agricultural-to-urban land conversion, to streamline the approvals process and better accommodate demands for growth while promoting efficient use of existing urban land. Some of the problems of the substandard settlements may be rooted in inadequate access to affordable serviced land. In these cases, municipalities and central government would need to work together to regularize the existing settlements (providing land registration and urban services Page 22 xvii where lacking), and reduce the chance of future appearance of such settlements by ensuring a more fluid supply of affordable land and housing. Over the medium term, municipalities could become more proactive in managing land by engaging in land subdivision, consolidation and readjustment schemes which directly influence private land use. A legal framework would need to be developed to permit this, drawing on experiences of other countries such as Poland. In the longer term the municipalities could also become more strategic using their own real estate transactions both as a tool of financial management and to stabilize the market. (v) Construction permitting and building inspection. Municipalities have recently acquired the authority for these functions, which are an important means of implementing urban planning and regulation. Construction without proper permitting is a persistent problem in some municipalities for several reasons, including the absence of planning frameworks, the high costs of construction impact (connection) fees paid at the time of permitting, unaffordable regulations, and the unwieldy approvals process itself. Donor assistance is being provided to simplify the permitting process, e.g. through one-stop shop approaches. (vi) Property tax and land use . The local governments’ fiscal reliance on an upfront construction fee, coupled with the exemptions in property taxation, raise the costs of land development at the building stage rather than influencing its outcome (type of land use). The overall structure of construction- and property-related taxation should be examined to determine possible distorting effects on the availability of new serviced land. Further refinement of property taxation should take account of its non-fiscal impacts and potential as a tool for managing the land market. The government might also consider ways to administer more efficiently the property transfer tax, not only for the sake of revenues and land market functioning, but also as a window to market information on current transactions. In conclusion To continue its growth trend and overcome poverty and unemployment, FYR Macedonia will need to rely increasingly on urban economies and their ability to support higher- value sectors and new private enterprises. The policy and institutional frameworks affecting cities and urban local governments are central challenges today. A decentralization program is in place that is sound in design and provides a good platform for responsive local governance. FYR Macedonia is one of the few countries in the South-East Europe subregion that has “fiscal space” for significant new public investment. To take full advantage of these opportunities, including the resources that will come with EU pre-accession, municipal governments will have to fulfill a greater role for which they are insufficiently prepared. How well the municipalities and central government together address the continuing issues in municipal finance, local service delivery, and urban land management will have major implications for sustaining growth, equity, and continued integration in the external economy. Page 23 xviii Page 24 1 The current context of urban and municipal development A. INTRODUCTION AND BACKGROUND 1.1 The present study examines the challenges facing municipal governments in FYR Macedonia. The attention here is focused on issues regarding municipal financial management, communal service delivery (particularly for infrastructure services), urban planning and land use management, with a relative emphasis on secondary cities. 1.2 There are several reasons why a policy note on this subject appears timely. First, while the national economy has returned to a solid growth path in the past few years, ensuring continued recovery and tackling persistent problem areas, such as unemployment, will require exacting a better performance from the cities, which are invariably the platforms for economic diversification, private investment and enterprise creation. Second, the urban population and urbanization rate continue to increase as expected for a country undergoing economic development and aspiring to the European norms. Third, poverty has proven particularly tenacious in urban areas despite the wider opportunities normally found there. Fourth, the political and fiscal decentralization launched in 2005 has conferred new responsibilities and new resources on local governments, creating high expectations and increased demands on the part of constituencies. Finally, FYR Macedonia’s recently-won status as an EU candidate raises the stakes further for good local governance and resource management 1.3 This introductory chapter provides some further context for these developments, in terms of the challenges they pose for urban areas and their governments. Chapter Two examines issues for financial management of municipalities under the decentralized regime, and the attendant need for improving local government capacity. The third chapter highlights questions in the area of communal services, where municipal governments retain overall provision and supervisory responsibilities of the local public enterprises. The fourth chapter focuses on urban planning and land management, an area critical to the efficient functioning of cities and for which municipalities have acquired new obligations. The approach of the report is to assemble existing data from many available studies, both by the World Bank and by other sources, and information obtained from interviews in the country to articulate ideas and recommendations for consideration by the Government elected in July 2006, by municipal governments, and by other stakeholders. B. A FRAGILE RETURN TO GROWTH 1.4 Since the political-economic crisis of 2001, FYR Macedonia has resumed an upward trend of economic growth averaging about 4 percent in 2004 and 2005. (Figure 1.1) Macroeconomic management has been sound and even rather conservative, as reflected in basic indicators on the external current account, public debt, and government expenditures in reasonable ranges, given the country’s income level and relative to neighboring countries. FYR Macedonia has depended quite heavily on private transfers Page 25 2 from abroad (including migrant remittances), however, which account for 18 percent of GDP —even higher than Albania’s rate of 15 percent. 2 (World Bank 2006) While the country’s growth rate is respectable it is still below that of most of its neighbors in South East Europe (SEE). Figure 0-1 FYROM has resumed a growth path, but below that of its neighbors Source: Draft FYR Macedonia Country Partnership Strategy FY07-10, ECA Pre-Upstream Review, PowerPoint, 8/3/06 1.5 The economy does not depend on any dominant sector and all of them have contributed to the recovery, albeit erratically. (Table 1.1) Generally, sectors offering relatively low incomes (agriculture, construction and trade) have accounted for most of the growth in recent years. Agriculture predominates in the Southeast region, where it accounts for 36 percent of employment compared to an average of 11 percent for the country overall. (SSO, MLSG and UNDP, 2004a) Industry is quite balanced as a source of employment across statistical regions 3 other than Southeast, averaging 31-40 percent in each although slightly higher (49 percent) in the East. The services sector, much of which has been developed since the transition and therefore located by market criteria 2 The exact composition of these figures is unclear but presumably consists mainly of remittances from migrants abroad. 3 Reference is made here to the eight statistical regions according to the Nomenclature of Units of Territory for Statistics), or NUTS-3 level. These are Pelagonia, Vardar, Northeast, Southwest, Skopje, Southeast, Polog, and East. GDP Annual Growth -6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 8.0 10.0 2001 2002 2003 2004 2005 G r o w t h r a t e ( i n % ) Albania Bosnia and Herzegovina Croatia Macedonia Serbia Montenegro Page 26 3 rather than central planning, is quite concentrated in the region and city of Skopje, where it generates about 68 percent of employment versus about 50 percent or less elsewhere. Table 0-1: Recent Economic Indicators. 2002 2003 2004 2005 GNI per capita (‘000 MKD) 119 123 130 138 GDP (Billion MKD) 244.0 251.5 265.3 284.0 Real growth rates per annum: GDP growth 0.9 2.8 4.1 4.0 Agriculture -2.0 4.8 6.2 3.1 Industry -0.8 5.1 -0.8 6.8 Manufacturing 0.7 3.2 -0.3 7.0 Construction 0.6 13.3 7.4 -5.0 Services 1.5 1.0 5.7 3.8 Trade 5.4 1.8 15.7 7.9 National poverty headcount index 21.4 21.7 20.5 … Unemployment rate … 36.7 37.2 37.3 Source: World Bank data. For national accounts, 2004 and 2005 are estimates. Source: ECSPE, Western Balkans Poverty Assessment, “FYR Macedonia: Growth and Poverty, 2002-2004”, June 1, 2006 1.6 Despite its recent achievements the economy reflects a number of thorny structural problems. Unemployment, stubbornly holding at 37 percent for the past three years, remains dramatically higher than in neighboring countries, with Bosnia and Herzegovina coming closest at 22 percent. Only the capital region offers an unemployment rate below 31 percent, with 27 percent in the city of Skopje. (SSO, MLSG and UNDP 2004a) While there are administrative reasons for some of the high reported unemployment, the problem is real. 4 Many of the old public enterprises have closed, fewer new establishments have appeared in their place to provide significant job growth, and private investment and productivity are low. The private sector still accounts for less than half of employment outside of agriculture. 1.7 Many weaknesses within the real economy are evident, although it is more difficult to explain FYR Macedonia’s outlier status on unemployment which predates independence. The latest Doing Business survey reveals that on many indicators (e.g., dealing with licenses, registering property, getting credit, protecting investors, etc.), the country is not rated much worse and is sometimes better than the ECA average, although invariably behind the OECD. Starting a business is clearly more problematic, however, requiring 13 procedures and 48 days in FYROM versus 9.6 and 36 (respectively) in the 4 The national Employment Agency records very much higher unemployment than reported in the census, because the agency pays health insurance for persons on its rolls. However, the figures reported here are from the census and are based on definitions used in the Labor Force Survey, consistent with standard international definitions. (SSO, MLSG and UNDP 2004b) The Household Budget Surveys, using different sampling methods and definitions, obtain somewhat lower figures —33 and 31 percent in 2002 and 2004, but still very high by international comparison. Page 27 4 ECA Region (and 6.5 and 20 in the OECD). 5 The EBRD-World Bank Business Environment and Enterprise Performance Survey (BEEPS) of 2005 paints a less positive picture of FYR Macedonia’s performance relative to that of the SEE or ECA comparators with respect to 14 out of 21 indicators. The gap is particularly pronounced with respect to contract violations, anti-competitive practices, crime and corruption, financing, electricity and telecommunications. 6 The Government elected in July 2006 has identified goals of improving the business environment in these areas. 1.8 Some of the issues hampering enterprises may be rooted in the local level and hidden in national averages. For example, according to a standard BEEPS question on the number and duration of “inspections by municipal police” 7 , firms in the FYROM sample reported much higher problems than did their counterparts in SEE or ECA overall. 8 1.9 How do the economic prospects and priorities appear to residents in specific localities? Many municipalities have undertaken participatory exercises of local economic development strategic planning (LED SP) in the last few years, which provide an interesting window to the perceptions of local stakeholders. (Box 1.1) There is a lot of common ground in these perspectives, notably in the emphases placed on the needs for better infrastructure, more responsive and professional municipal administration, and a vibrant entrepreneurial sector. In each of the priority areas the LED strategic plans also highlighted the need for concerted action at the national level to help realize the local goals by providing policy and legal frameworks (e.g., for public-private partnership), basic analysis (e.g. of prospects for tourism and agro-processing), and a supportive investment climate. 5 www.doingbusiness.org . As of January 2006 the one-stop shop system began to function in FYR Macedonia for registration of new companies. It is said to require only 3-5 days for registration. (Macinvest and UNDP, 2006) 6 There are some apparent inconsistencies where the BEEPS suggests FYROM performs less well than regional comparators on certain indicators (e.g. business licensing and financing), while Doing Business suggests the opposite. The ongoing World Bank-supported Business Environment Reform and Institutional Strengthening Project (BERIS) are studying such issues in detail. 7 Since FYR Macedonia does not have a municipal police force, this question could have been interpreted either as referring to the national police located in the municipal jurisdication or, may be more likely, the municipal inspectorates. 8 About 2.7 inspections in the previous year in FYROM versus 1.5 in SEE and less than 1 in ECA. Each of these encounters averaged over one hour in FYROM versus 0.7 hours in SEE and 0.5 in ECA. Page 28 5 Box 0-1: How local stakeholders perceive their economic and social development priorities S everal donors have supported local economic development strategic planning (LED SP) initiatives in FYR Macedonia in the past few years, together covering a large share of municipalities across all regions. LED strategic plans typically involve a participatory process led by the local government but involving a wide range of stakeholders engaged in: i) identifying strengths, weaknesses, opportunities and threats (SWOT analysis), ii) formulation of a collective vision and statement of goals (mission), iii) identifying specific objectives, and iv) prioritized tasks and activities (projects or other measures) to realize the goals. Donors supporting various municipalities in LED SP to date include the European Agency for Reconstruction (EAR), GTZ, SIDA, Swiss Development Cooperation, UNDP, and USAID. In the first of these programs in 2002-04, the USAID Local Government Reform Project selected 12 municipalities under various criteria to represent ten percent of the 124 municipalities existing at the time. These were: Debar, Struga and Tetovo in the west, Bitola, Krushevo and Negotino in the center-south, Kochani, Kriva Palanka, Kumanovo, and Sveti Nikole in the north, and Centar and Karpos in Skopje. Several other municipalities including Veles were later added to the USAID program. Overall, these plans concurred on five major priorities for local economic development: a) Improving infrastructure —especially local roads, water supply and treatment systems, regional landfills; public marketplaces, parks and green spaces; and facilities for sports and recreation, education, health care and community centers. b) Strengthening capacities of local administration and municipal management —with the emphasis on modernizing management practices and separating political from administrative decisions. Concrete actions include creating one-stop shops and streamlining the local bureaucracy. c) Development of agriculture and processing of agriculture products —actions range from improving agriculture production to enhancing entrepreneurship at the stages of marketing, processing, packaging, etc. d) “Integrated development of municipalities through tourism” (focused on cultural heritage and natural resources) —stressing not enclave-type investments but rather developments that reduce poverty and create employment sustainability in the local region. e) Development of entrepreneurship —seen as key to completing the transition to a market economy and to create a viable small enterprise sector. Related goals include attracting new business investment, fostering public-private partnerships, business incubators and labor force training. Although the first round of strategic plans supported by this program were not linked to an available envelope for financing the priority projects and activities, it is estimated that as of early 2006 the municipalities had managed to complete about one-third of them and about 40 percent were under implementation. The second round of the USAID-supported program is focusing more intently on integration of LED strategic planning with medium-term budget planning. Source: LGRP-USAID, 2005 and interview with USAID local staff, Skopje, May 2006 C. T HE D EMOGRAPHIC C URRENTS 1.10 Between the last two censuses (1994 and 2002), the population of FYR Macedonia grew by 0.48 percent. While it appears difficult to obtain a definitive estimate of the rate of urban growth, it is evident that the urban population increased more than the total and that the urbanization rate is therefore on the rise. 9 Some of the 9 The changes in territorial organization (increasing municipalities from 34 to 123) in 1996 did not specify which settlements had urban features; consequently the 2002 census did not distinguish urban and rural Page 29 6 urban growth reflects spontaneous relocations that took place during the regional strife of the late 1990s through 2001, channeling internal movement to Skopje and a few other cities especially in the northwest. Net external migration during the inter-census period —no doubt a response to the country’s unemployment situation—amounted to 31,000 persons or about 1.5 percent of the 2002 total population of 2.022 million. The largest rates of emigration are found in the west and southern municipalities. (SSO, MLSG and UNDP, 2004b) 1.11 Continued urbanization can be expected as part of the normal economic development process. It is projected that the urban share of population will rise from the present rate of about 65 percent to about 78 percent in 2020 (UN, 2006), which would bring it close to the EU average. 1.12 Most of the urban population is distributed across quite small municipalities, a pattern shared with a neighboring country, Albania. (Figure 1.2) The city of Skopje, which currently consists of ten municipalities with a total population of nearly 500,000, clearly dominates the urban system as it accounts for roughly a third of urban population. Only four other municipalities (Bitola, Gostivar, Kumanovo, and Tetovo) of the current 84 exceed 80,000 residents. The small size of the remainder underscores the challenges they face in mustering the capacity to meet their new roles. 1.13 Certain other demographic trends are of particular interest for urban policy and municipal management. One is that, despite the low population growth rate, there has been a continuous increase in the numbers of both marriages and (especially) of divorces in the inter-census period, implying new household creation and demand for housing; adding to this momentum is the reduction in average household size. It is indicative that the number of dwellings grew by 20 percent between 1994-2002, in contrast to a 3.9 percent growth of population. The phenomenon of single-parent (especially maternal headed) households has also become quite common, accounting for 7 percent of families nationally. These demographic trends indicate pressures on the housing market and especially for affordable housing, the supply of which can be aided or constrained by developments in urban planning and land management. 1.14 Second, the population is aging in most regions. The age dependency ratio of youth (below age 15 relative to the working-age population) is falling, while that of the elderly population (age 60 and over) is rising across most of the country. This trend signals that municipalities will perceive reduced demands for school-related services but rising needs for special services for the elderly, including adaptation of urban infrastructure such as transport. It also underscores a growing urgency to increase employment of the working-age group in-between. residents and only the 1994 census cited an urban population (1.163 million or 59.8 percent of the total). (SSO, MLSG and UNDP 2004b) UN estimates show the urban population increasing from 1.192 in 1995 to 1.4 million in 2005, an annual growth rate of 1.6 percent (UN 2006); however, the UN publication of two years earlier had indicated much lower urban growth for this period, 0.55 percent p.a. (UN 2004). The difference may be due to the fact that in the 2004 territorial reorganization, which reduced the number of municipalities from 123 to 84, the characterization of rural or urban status was based partly on which had previously served as municipal centers rather than on actual settlement features. Page 30 7 1.15 The ethnic distribution of the population poses special challenges for municipal management as well. Nationally, according to the 2002 census ethnic Macedonians comprise 64 percent of the total population and Albanians 25 percent, with the remaining 11 percent (in descending order of share) being Turk, Roma, Serb, Bosniac, Vlach and other. In the intercensus period the national share of Macedonians declined very slightly while that of the Albanian, Roma and Bosniac minorities increased and the others fell. The minority ethnic groups each have lower rates of labor force activity, and all but the Serbs and Vlachs have higher unemployment rates, than the Macedonians. The minorities feature higher age-dependency ratios as well. (SSO, MLSG and UNDP, 2004a) The territorial reorganizations have aimed to maintain a considerable degree of heterogeneity within most municipalities and regions, although relatively few are truly multiethnic (i.e., with no single group holding the population majority). Only 21 of the 84 municipalities have other than a Macedonian majority. Local government therefore represents the real frontier for ensuring that governance remains inclusive and delivers benefits to all constituents. The ethnic differences within the active labor force also underscore the challenges felt at the local level to stimulate employment creation and employability for all groups. Figure 0-2: Population is dispersed among mainly small municipalities 2% 23% 24% 11% 23% 9% 8% 3% 30% 17% 6% 20% 13% 11% 0% 5% 10% 15% 20% 25% 30% 35% 1,000-4,999 5,000-9,999 10,000-24,999 25,000<49,999 50,000-74,999 75,000-99,999 > 100,000 Range of Population Size S h a r e o f M u n i c p a l i t y P o p u l a t i o n Municipality Albania Municipality FYROM Source: 2001 Census, INSTAT for Albania and 2002 Census for FYROM. D. P OVERTY HAS APPEARED INTRACTABLE , ESPECIALLY IN URBAN AREAS 1.16 FYR Macedonia is distinguished within its subregion in terms of the patterns and persistence of consumption poverty, which has hovered around 21 percent through 2002- 2004. Despite the resumed economic growth the overall incidence of poverty declined less than in Albania or Serbia between the last two household budget surveys. (Table Page 31 8 1.2) FYR Macedonia is the only country among the four compared here to have experienced an increase in the numbers of urban poor people, and much higher numbers of urban poor than rural poor, in the last year surveyed. 10 Table 0-2: Poverty Status by Urban-Rural Location in Western Balkans Source: ECSPE, Western Balkans Programmatic Poverty Assessment, “Poverty Profile: Changing Nature of Poverty?”, PowerPoint, June 1, 2006 1.17 In 2004 consumption poverty rates were almost as high in secondary urban areas (20.5 percent) as in rural areas (21.8 percent), with only the capital city having seen significant improvement (to 17.9 percent, down from 20.4 percent in 2003). Consequently, FYR Macedonia featured greater urban-rural convergence in consumption than neighboring countries, but reflecting a weak rather than strong performance in tackling poverty. (Appendix Figure A1.1) Inequality (as measured by the Gini coefficient) is also distinctly higher in FYR Macedonia than in the four comparator countries —0.37 against their average of 0.28. The Gini in urban areas improved slightly in 2004 to 0.36, only a little below the rural rate (0.39). 10 Note that the methodology of estimating consumption poverty used by the State Statistics Office does not include spatial price adjustments. Since larger cities tend to have higher cost of living than smaller urban or rural areas, this omission may tend to underestimate poverty rates at least in Skopje and overestimate rural rates —thus accentuating the country’s rather unusual urban-rural poverty comparison. (ECSPE, Western Balkans Programmatic Poverty Assessment, “FYR Macedonia: Growth and Poverty 2002-04”, June 2006.) Change in Poverty Year1 Year2 No. of people % change Albania: 2002-05 All poor 813,196 575,659 -237,537 -29.2 Urban 257,690 151,811 -105,879 -41.1 Rural 555,506 423,848 -131,658 -23.7 BiH: 2001-04 All poor 664,700 682,000 17,300 2.6 Urban 120,800 121,400 600 0.5 Rural 543,800 560,800 17,000 3.1 FYR Macedonia: 2002-04 All Poor 431,785 416,369 -15,416 -3.6 Urban 212,105 232,256 20,151 9.5 Rural 219,680 184,112 -35,568 -16.2 Serbia: 2002-05 All poor 805,600 715,295 -90,305 -11.2 Urban 367,253 227,453 -139,800 -38.1 Rural 410,610 453,675 43,065 10.5 Page 32 9 Table 0-3: Consumption Poverty Rates by area, 2002-2004 Share of population living below poverty line 2002 2003 2004 All Macedonia 21.4 21.7 20.5 Urban 18.4 21.3 19.5 Skopje 19.9 20.4 17.9 Other 17.5 21.8 20.5 Rural 25.3 21.3 21.8 Source: ECSPE, Western Balkans Poverty Assessment, “FYR Macedonia: Growth and Poverty, 2002- 2004”, June 1, 2006 1.18 In most countries urban poverty incidence remains much lower than rural because cities offer deeper labor markets and easier access to services and formal safety nets. So the unusual poverty picture in Macedonia suggests real dysfunction in the urban economies. Unemployment rates are significantly higher for the urban poor than for the rural poor, and are highest (61 percent) for the poor in Skopje. The employment rate of the poor in the capital has stagnated at only 22 percent between 2002-04. (Appendix Table A1.1 11 ) The weak employment performance of the capital in this respect is surprising, given the obvious dominance of its economy. 12 1.19 Vulnerability to poverty is also a concern. Raising the poverty line to twice its estimated base level would increase the incidence from 20.5 to 55.9 percent in 2004. The urban population is only slightly less vulnerable than the rural by this calculation. (Appendix Table A1.2) 1.20 Urban areas provide the major sources of household income, however. It is noteworthy that unlike in some countries of the subregion, informal nonagricultural activity in FYR Macedonia is considered to account for a very small share of total income —less than 5 percent for urban and 6.3 percent for the rural residents. On the other hand, formal nonagricultural activities, which by their nature derive from the diversification and integration of urban economies, provide the lion’s share of income even for the rural population. Private transfers, which would include domestic as well as foreign remittances from migrants, are also very significant for rural residents—over 9 percent of their incomes, or three times public transfers (other than pensions). (Appendix Table A1.3) These patterns underscore the importance that urban economies hold for both rural and urban residents, by widening opportunities and resource exchanges. 11 Based on HBS data, which are not completely comparable to LFS data in Table 1-3. 12 For example, only the Skopje region among the eight statistical regions, showed a positive average annual growth rate (7.7 percent) of value-added in the nonfinancial sector in the 1998-2002 period. (SSO, MLSG and UNDP, 2004b) Page 33 10 1.21 While information has improved on consumption poverty as cited above, less is known in FYR Macedonia about the non-monetary aspects, or asset poverty —especially as regards housing and economic infrastructure. Reliable data, spatially disaggregated, on the quality of infrastructure services and of dwelling conditions in FYR Macedonia are scarce, as acknowledged in the Poverty Assessment. (World Bank 2005) It will be important for future household surveys to expand their scope of inquiry into infrastructure and housing conditions. 1.22 At least as far as business is concerned, the most recent investment climate survey (BEEPS 2005) found a low share of firms reporting problems in infrastructure (electricity or telephones), although delays and outages are clearly worse than in the EU-8 countries. According to the most recent household budget survey, access to electricity and water are not much of a problem overall, especially for the urban population, but neither reliability nor affordability were examined. The Poverty Assessment found that “housing poverty” (defined as crowded conditions with less than 6 m 2 per person, or no sewerage disposal in the dwelling in urban areas) affects 7 percent of the population—not as large as “education poverty” but enough to raise the effective overall poverty rate by one-third. 1.23 Substandard settlements. The formal poverty data do not take full account of residents of informal urban and peri-urban settlements. 13 These are areas that have been developed in an unplanned manner, typically without formal title or building permits, on either public land within municipal jurisdictions (or as is often the case, outside the municipal boundaries), on illegally subdivided private land, or in open areas such as river and canal banks. In 2003-2004 the World Bank sponsored an analysis and series of workshop discussions of so-called “substandard settlements,” which documented an array of inadequacies. As reported in the 2004 “Urban Policy Note” the counterparts involved in that activity identified institutional and planning failures, not the lack of physical investment as such, to be the crux of issues with substandard settlements. (World Bank 2004) 13 The Poverty Assessment ( World Bank 2005), notes that the Household Budget Surveys of 2002 and 2003 are believed to under-sample considerably residents of substandard housing areas and do not collect information on security of tenure. (p. 47) Page 34 11 Box 0-2 Conditions in substandard settlements As part of a process of analysis and workshops starting in late 2003, the Bank and counterpart agencies 14 sponsored a questionnaire survey of the fourteen largest cities in March 2004, which focused on the extent of coverage and service shortcomings in water supply, wastewater collection and disposal, solid waste management, and household energy. This inquiry was used to identify the basic conditions and extent of the substandard settlements, which accounted on average for 11 percent of the population of the cities surveyed. 15 (See table) Substandard Settlements (SSS): Size, Population and Coverage with Basic Infrastructure City Surface Area of SSS (ha) Share of Territory of the City (%) Population living in SSS Share of City Population Road Coverage Water Supply Coverage Sewage Network Coverage Skopje 600 8.4% 30,000 6.0% 40% 30% 15% Kumanovo 177 9.4% 13,266 12.7% 15% 42% 17% Prilep 157 10.2% 13,850 17.0% 10% 40% 10% Bitola 100 4.5% 10,000 1.2% 27% 63% 37% Veles 171 8.9% 7,758 13.4% 60% 90% 80% Stip 60 7.4% 3,400 7.0% 20% 50% 30% Kocani 20 NA 3,000 8.1% 20% 15% 15% Strumica 23 2.5% 2,800 4.5% 10% 30% 10% Gostivar 1.5 20% 1,000 1.2% 10% 90% 0% Tetovo 100 14% NA NA 20% 90% 0% A representative sample household survey was then conducted in 12 such settlements in three cities with the highest incidence of both substandard areas and service deficiencies —Skopje, Prilep and Kumanovo. The respondents indicated a high variability in access and quality of services. Several of the findings are particularly worth noting: · The socioeconomic features of the residents included high rates of unemployment, income vulnerability, and dependence on informal activity. The largest substandard settlements are mainly inhabited by ethnic Roma and Albanian families; · No more than 40 percent of the residents reported being migrants from rural areas; · Two-thirds reported feeling safe from eviction, although many did not have documents proving ownership; · Most reported paying property tax and utility bills; · The physical condition of their housing was often very inadequate (cramped, of nonpermanent materials, not weatherproofed, or in hazardous location), especially in Skopje; · The most serious infrastructure problems reported were a lack of sanitary latrine disposal and unsatisfactory solid waste collection. Access to water, sanitation and solid waste collection was generally best in Skopje and worst in Kumanovo (the second largest city). Inadequate vehicle access was a problem in most of the settlements, and public transport was readily available (within 500 meters) only in Skopje. Source: World Bank 2004 14 Led by the Physical Planning Department of the Ministry of Environment and Physical Planning and including other central government ministries, the association of local governments (ZELS) and donors. 15 The report also notes, however, that the FYROM National Strategy for Poverty Reduction (2002) cited an estimate of 20 percent of the total urban population living in substandard settlements, about 274,000 people. Page 35 12 E. D ECENTRALIZATION HAS GIVEN MUNICIPALITIES GREATER RESPONSIBILITIES 1.24 In 2005 FYR Macedonia began formally implementing the first phase of fiscal and political decentralization, a process initiated under the Ohrid Framework Agreement of 2001 that ended a period of interethnic conflict. Many countries throughout the world have undertaken such decentralization to shift responsibilities to local governments for service provision and revenue mobilization, under the principle of subsidiary and with the aims of achieving more efficient resource allocation and better accountability to citizens. As the process was launched in FYR Macedonia with the added intent to promote national harmony, the expectations for decentralization are particularly high. 1.25 Macedonia has a long tradition in local government management and service delivery to local population. Managing the current decentralization is particularly challenging because of the relative speed with which the process was put in place through three, more or less simultaneous, developments: (i) a new territorial organization, (ii) the handover of important new competencies (ranging from building permitting and inspection, property tax collection, and local economic development, to the management of school buildings and social welfare institutions), and (iii) a new (but not fully completed) array of related legislation and regulations. (Box 1.3) 1.26 A key problem is the "one size fits all" nature of the decentralization framework which does not sufficiently distinguish among large and small, or urban and rural, municipalities having very uneven experience and capacities. The 50 municipalities that did not hold municipal status and functions before transition (so-called "rural", although their character is mixed) are particularly weak and unprepared, as compared to the 34 that have served as regional or major urban centers for some time. Differentiated rules and regulations —if perceived as discretionary—are not the answer, especially given the domestic political sensitivities across the country. But the wide variance across these two categories of municipalities in human and fiscal resources will require policy attention, to ensure success of the decentralization. 1.27 Where decentralization has been implemented for longer periods and the experience has been studied, several lessons and issues emerge of interest to FYR Macedonia. (World Bank 2005b and 2001, Burki, Perry and Dillinger 1999) One of the most important points is to ensure effective coordination among tiers of government. This implies the need for continuous strategic guidance and support of the local governments by the central government agencies. Equally important is inter-municipal cooperation, especially regarding functions that have economies of scale (e.g., solid waste disposal), and those that have spillover benefits or costs affecting multiple jurisdictions. The framework legislation permits, and Ministry of Local Self Government encourages, the municipalities to group together voluntarily to share functions and to contract for services from larger municipalities. 1.28 A second lesson from decentralization elsewhere is that it cannot be assumed to achieve a more responsive government or better delivery of local services. What are therefore critical are measures to: i) enhance capacities and training of the local authorities, ii) ensure accountability to constituents, and iii) monitor performance. In Page 36 13 FYR Macedonia the mayors elected in 2005, their councils, and the association of local governments are clearly taking their new responsibilities very seriously, and the population appears to hold a generally positive and hopeful, if cautious, view of the decentralization. (IRIS and IDSCS 2006) The areas where issues arise and further attention may be needed are discussed further in the following chapters. Box 0-3 The evolving legal framework for decentralization Decentralization in FYR Macedonia has taken place through a series of laws and regulations affecting the territorial organization, the distribution of competencies, and the intergovernmental financing framework. While a first Law on Territorial Organization in 1995 had established 123 municipalities out of the previous 34, the second Law on Territorial Organization in 2004 reconsolidated them into the present 84 municipalities. The Law on Local Self Government (January 2002) defines and regulates municipal operations and activities in a comprehensive manner. The law is supported by other pertinent laws and regulations, the most important of which include the Law on Financing of the Units of Local Self Government (July 2004); the Law on Property Taxes (September 2004); and the Law on (so-called) Utility Fees 16 (September 2004). Several other major laws concerning functions under the responsibility of municipal government, such as those On Construction Land, On Spatial and Urban Planning, On Public Enterprises, On Communal Activities, On Water Supply and Urban Waste Waters, and On Waste Management, were also approved in 2004 or 2005. The laws permit municipalities to regulate and perform activities of local importance. The list of municipal competencies includes: (i) urban and rural planning; (ii) environmental protection; (iii) local economic development; (iv) communal activities (v) culture; (vi) sport and recreation; (vii) social welfare and child protection; (viii) education; (ix) healthcare; (x) protection against natural and man made hazards; (xi) firefighting; (xii) supervision of municipal competencies; and (xiii) other competencies determined by law. The Law on Local Self Government allows municipalities to borrow from the domestic and foreign capital markets, although the government has currently restricted further debt accrual until at least the end of 2007. F. EU C ANDIDACY CREATES ADDED MOMENTUM 1.29 The transfer of competencies to the municipalities in FYR Macedonia has been designed to ensure consistency with the general European practice of local self- governance and to further the country’s readiness for accession to the European Union. In December 2005 FYR was granted status as a candidate for EU membership. The process of accession will create both opportunity and responsibility for the municipalities. To make the best use of future pre-accession and structural funding, municipalities together with central government will have to take a very disciplined approach to selecting and cofinancing investments. G. C ONCLUSIONS 1.30 Overall, FYR Macedonia is well-positioned on a positive economic track. To continue this course and overcome persistent obstacles the country needs to exact a stronger and more consistent performance from urban economies. Despite many 16 This title is a misnomer, since the law concerns small communal charges and fees mainly for business operations, and does not address tariffs of infrastructure service utility companies. Page 37 14 achievements the intransigence of urban poverty is particularly worrisome. The challenge for the cities is not so much accommodating population increase, but rather creating workable services, land, housing and amenities that respond to the needs of households and firms in an ever more-competitive environment. The policy and institutional frameworks affecting cities and urban local governments —which typically host the higher value-added sectors, most private firms, and foreign investors critical to the country’s economic future—therefore need to be scrutinized. Due to sound macroeconomic management FYR Macedonia is one of the few countries in the South East Europe subregion that has “fiscal space” for significant new investment. To take full advantage of this opportunity, including the resources that will come with EU preaccession, municipal governments will need to play a greater role for which they are inadequately prepared. The next chapters explore the issues concerning three major areas of challenge: municipal financial management and capacity building, the provision of communal services, and urban planning and land management. How well the municipalities and central government together address these areas will have important implications for sustaining growth, equity, and continued integration in the external economy. Page 38 15 Municipal financial management and capacity-building 1.31 FYR Macedonia has been elaborating a decentralization agenda since 1995, as outlined in the previous chapter, but its current phase began in earnest from 2001. As of mid-2005 a full package of fiscal framework laws entered into force to complement the devolution of competencies in public services delivery by establishing a local revenue base and the terms of intergovernmental fiscal transfers. 17 This chapter aims to assess the main dimensions of fiscal decentralization as they appear in this first year of implementation, and to identify several challenges that remain in reforming and strengthening Macedonia’s municipal financial management. A. T HE EVOLUTION OF THE POST - DECENTRALIZATION MUNICIPAL REVENUES 1.32 FYR Macedonia’s intergovernmental fiscal relations are based on a model which assigns own sources of revenue to the local government, in combination with various types of intergovernmental transfers that are supposed to bridge the gap between revenue and expenditure assignments. The current sources of municipal revenues can be defined as (i) own sources, (ii) transfers and grants from the budget, and (iii) borrowing. While this section takes a look at the structural composition and breakdown of municipal revenues and expenditures, the issue of raising revenues through debt (borrowing) is discussed separately. 1.33 The main changes to the municipal finance system introduced by decentralization are an enhanced local responsibility for raising revenues, as well as the possibility for municipalities to set rates of local taxes and fees within a given range at their own discretion. Before the devolution of powers, municipalities were unable to collect tax revenues on their own, since those were raised by the central government agency – the Public Revenue Office (PRO) – within each district. The PRO took charge of distributing (and redistributing) tax revenues to the municipalities, largely proportional to population. The new system of local tax administration and collection is intended to create better incentives for revenue mobilization since, from now on, all property tax revenues, business signage fees, etc. have to be generated within the municipal boundaries. 1.34 The structure of local government revenues is changing. Given the data limitations on detailed revenues for the years immediately preceding the decentralization (2003 and 2004), as well as the change in local fiscal responsibilities, any comparison of the financial data across time has to be interpreted with a large grain of salt. Nevertheless, some major characteristics of the municipal revenue structure in the pre- and (projected) post-decentralization periods can be observed. Table 2.1 shows the composition of local 17 The Law on Financing of the Units of Local Self Government (2004) is being implemented in two phases. The first phase started in January 2005, and includes agreement on distribution of VAT, methodology for distribution of capital, earmarked and block grants (excluding salaries of transferred staff of schools, culture and community social services institutions). The second phase of decentralization will start with the transfer of block grants as defined in the LLSG when municipalities: meet conditions of the first phase by resolving previous debt arrears; possess staff for financial management; show good financial results for at least 24 months; and have no new arrears to suppliers exceeding ordinary terms of payments. Page 39 16 government revenues prior to decentralization as well as the projections for the current fiscal year 2006. Page 40 17 Table 0-1: Structure of Municipal Government Revenues, in thousand MKD. 2003 % 2004 % 2006* % Tax Revenues 2,887,028 65.6 3,195,760 64.7 5,164,354 45.2 711 Income Tax (including PIT) 254,174 2.2 713 Property Taxes, of which 651,546 14.8 688,810 13.9 1,387,070 12.1 713111 Property tax 384,372 3.4 713211 Inheritance and gift tax 47,930 0.4 713311 Tax on transfer of real-estate and rights 812,979 7.1 717 Tax on Specific Services, of which 2,231,893 50.7 2,503,551 50.7 3,512,276 30.7 717112 Business Signage Fee 244,125 2.1 717115 Usage of roads/vehicle registration 76,297 0.7 717116 Communal Tax for use of public lighting 353,101 3.1 717137 Construction Permit Fee 2,508,334 21.9 Other Taxes on Specific Services 330,419 2.9 Other Tax Revenues 3,589 0.1 3,398 0.1 10,834 0.1 Non-Tax Revenues 156,190 3.5 310,441 6.3 1,542,861 13.5 721 Entrepreneurial and Property Income 12,450 0.3 10,228 0.2 2,323 722 Taxes and Fees 87 80 43,957 0.4 723 Administrative Taxes and Fees, of which 14,938 0.3 142,788 2.9 964,134 8.4 7230 Education and Training 199,864 1.7 7231 Supplementary activities in education 582,041 5.1 7239 Leases 56,879 0.5 Other Admin Taxes and Fees 125,349 1.1 724 Other Government Services 27,839 0.6 35,870 0.7 63,947 0.6 725 Other Non-tax Revenues 100,875 2.3 121,475 2.5 468,501 4.1 Capital Revenues** 14,445 0.3 83,079 1.7 419,483 3.7 Transfers and Donations 1,294,114 29.4 1,282,182 25.9 4,310,591 37.7 741 Transfers from Other Levels of Government, of which 1,219,388 27.7 1,258,232 25.5 3,801,578 33.2 741113 Transfers from the budget of the funds*** 684,794 6.0 741114 Transferred surplus from previous year 401,759 3.5 741115 VAT Transfers 773,218 6.8 741116 Earmarked Transfers for Culture 57,875 0.5 741117 Transfers for Social Protection 407,213 3.6 741118 Transfers for Education 700,450 6.1 7412 Capital transfers 307,674 2.7 Other Transfers 468,595 4.1 742 Foreign Donations 44,060 1.0 23,950 0.5 356,630 3.1 743 Capital Grants 30,665 0.7 152,383 1.3 Domestic Debt 51,172 1.2 44,792 0.9 Sale of Securities 25,000 0.5 Revenues from Repayment of Loans 175 Total 4,402,947 100 4,941,429 100 11,437,290 100 Notes: *The 2006 budget is based on projections. While the 2003 and 2004 figures show the total for 123 municipalities, the 2006 budget is based on the aggregate figures for the 84 new municipalities. ** Capital Revenues by definition include all sorts of asset sales and concession revenues, but are almost exclusively generated by selling municipal buildings. Source: Ministry of Finance *** 741113 ‘Transfers from the budget of the funds’ represents the transfers from the ‘National Road Fund’. Page 41 18 1.35 Until fiscal decentralization took effect in mid-2005, transfers and donations played a secondary rule in municipal budgets next to own sources of revenue, accounting for only 28 percent of local revenues in 2003 and 26 percent in 2004. With the extension of local authority and fiscal decentralization, (earmarked) government transfers are projected to increase threefold, faster than the significantly rising total budgets, and are expected to provide one-third of the revenues of municipalities in 2006. The first actual post-decentralization figures available (for the second half of the fiscal year 2005) confirm this shift in the local revenue structure. 1.36 Prior to decentralization, the ‘Taxes on Specific Services’ were the most significant source of locally raised revenues, constituting around 50 percent of municipal budgets. Including fees for issuing construction permits, business signs, vehicle registration, public lighting, road usage, etc., these revenues continue to rise in absolute terms. However, given the concomitant increase in transfers, their relative share of the total budget is expected to decrease to 31 percent in 2006. In total, the magnitude of tax revenues, including property taxes, is expected to grow with decentralization, but the relative share of tax revenues would decrease from 65 percent in 2004 to 45 percent in 2006. Non-tax revenues, which are mainly collected through administrative fees, will gain in importance, but their contribution to local government budgets is expected to remain modest, at 14 percent. 1.37 Overall, the projections indicate that the self-financing capacity of local governments (‘own’ sources of revenue 18 , not including the revenues from personal income tax described below), amounts to 60 percent of municipal budgets in 2006. Such a high level of own source revenues is unmatched by other transition countries, where municipal budgets are more dependent on government transfers with own sources of revenue ranging between 5 percent in Lithuania and 40 percent in the Czech Republic. 19 However, FYR Macedonia’s high level of own government resources should be seen in the context of low levels of total local revenues. At 2006 estimations, the total local government revenues account for 3.8 percent of GDP (own sources revenues for 2.3 percent of GDP) figures far below the revenue level in further advanced transition countries of the region. 20 Moreover, a further increase in transfers, with a relative decrease in own source revenues, is to be expected once municipalities assume the full level of responsibilities envisioned in the second phase of decentralization. 18 Own Sources of Revenue include: (i) property taxes (including inheritance and gift tax, tax on transfer of real estates) and other local taxes established by law; (ii) local fees: administrative and other local fees; (iii) Local charges: for urbanization of construction land, charges for communal activities, charges for spatial and urban plans, and other charges; (iv) revenues from ownership: leasing, interests, and property sale; (v) Revenues from donations: financial donations are registered as revenue, donations in assets (land) are registered as municipal property; (vi) Revenues from other fines; (vii) Revenues from self-contribution: from citizens through a referendum regulated by the council; and (viii) Other revenues established by law. 19 Local government data based on Dillinger (2005). Countries included in the study are Latvia, Poland, Hungary, Czech Republic, Estonia, Lithuania, Slovenia, Slovak Republic. 20 Based on 2002 data local revenues as a share of GDP were 5.3 percent in Slovenia, 8.61 percent in the Czech Republic, 10.1 percent in Hungary, 10.8 percent in Latvia and 12 percent in Poland. Comparisons with Macedonia are not exact because its municipal budgets do not yet contain all operating costs for schools and social services. Page 42 19 1.38 Local governments are making strides forward in exploiting the potential of local revenues, but sources are not equally available in all municipalities. The increased municipal responsibility for tax collection can be expected to generate increased effort and more effective revenue mobilization. It is noteworthy that the ‘tax on transfer of real estate’ and especially, the ‘construction permit fee’, are estimated to amount to 47 percent of own source revenues (29 percent of total municipal revenues) in 2006. However, the bulk of those revenues, stemming from a solid construction sector and a gradually emerging real estate market, are collected in Skopje and some secondary cities. For example, 74 percent of the total national construction permit fees are raised in the capital city alone. These projections are contingent upon a speeding-up of the construction permitting procedures. The annual property tax itself plays a minor role in local revenues, as it is estimated to contribute only 3.4 percent of municipal budgets in 2006. 1.39 To strengthen the local governments’ financial base, the decentralization package added two new economic activity-related sources of local revenue. The intergovernmental fiscal system shares 3 percent of personal income tax (PIT) on a derivation basis and redistributes 3 percent of the value added tax (VAT) collected nationwide. These additional funds from VAT and PIT revenues, taxes that were formerly at the exclusive disposal of the central government, are estimated to contribute 9 percent to future municipal budgets and can be spent autonomously. Such intergovernmental transfers are of particular support to the revenue base of those newly formed municipalities that were heavily dependent on the regional redistribution of revenues in the past. Since decentralization took effect in mid-2005, these municipalities have been falling short of matching earlier revenues by relying on their own local tax and non-tax sources. For example, while certain cities like Demir Hisar, Gostivar, Strumica and Tetovo collected the equivalent of their total 2004 property tax revenues in the second half of 2005 alone, the average collection of property tax revenues for the newly formed municipalities 21 in this period reached only 17 percent of their 2004 amounts. A similar trend was observed for tax revenues from ‘Specific Services’. 1.40 In order to estimate and plan budgets and capital expenditures, municipalities depend on a predictable revenue stream. According to the 2006 projections 32 percent of the overall municipal budget revenues, excluding earmarked transfers, are fully predictable, while other substantial revenue sources like the construction permit fee are neither recurrent nor entirely certain when drafting budgets. 22 Many municipalities with relatively high levels of per capita revenues rely on these irregular sources. For 2006, an average of 22 percent of local revenues are supposed to be realized by construction permit fees, which are highly contingent upon the dynamics of the construction sector. In short, a low level of budget predictability might not mean a low revenue base, but it 21 Newly formed municipalities include local governments that were not among the 34 traditional core municipalities that existed prior to 1995. 22 As defined in the Law on Communal Fees and the Property Tax Law the following revenues are considered to be predictable: annual property tax, income tax, business signage fee, public lighting fee, communal fee paid for usage of roads, transfers from the national road fund, and the VAT transfers. Page 43 20 limits the local authorities’ ability to commit to effective mid-term investment planning (discussed further below). B. T HE STRUCTURE AND FUNDING OF LOCAL GOVERNMENT EXPENDITURES 1.41 The local expenditure assignments have been redefined with the adoption of the LLSG and budget reporting has been changed. 23 Once the second phase of decentralization is fully operational the social sector functions and services, education, fir-fighting and culture will be financed by earmarked grants and revenue generating activities related to these functions. 1.42 Decentralization causes an increase in local expenditures, with operating expenditures growing the strongest. While, at this early stage of decentralization, the exact changes in the economic classification of expenditures cannot be certain, one structural trend is obvious. With new (if incomplete) expenditure responsibilities in the social and educational sphere delegated to local authorities, the total operating expenditures (wages/allowances and expenditures for goods and services) are bound to increase dramatically, in both absolute and relative terms. Figure 2.1 below shows the structure of expenditures pre- and post-decentralization, where operating expenditures increase from 40 percent in 2004 to 53 percent in 2006. Taking into account the increase in total municipal budgetary volumes from 4.9 billion MKD in 2004 to 11.4 billion MKD in 2006, the relative decrease of capital expenditures (from 56 percent in 2004 to 44 percent in 2006) is put into perspective. It appears to be the practice to charge debt service payments to the capital expenditure accounts, which tends to overstate the magnitude of capital expenditures. 23 The new reporting framework of expenditures provides for both a functional and economic breakdown. The expenditure breakdown by functions will be a useful tool to compare sectoral aspects of decentralization between FYR Macedonia and other similar countries, especially other candidate countries and the EU-8. In addition, this framework will be helpful in analyzing functional expenditures behavior across different municipalities in the future. Page 44 21 Figure 0-1: Structure of municipal expenditures, in thousand MKD. 545 563 1,552 1,460 1,324 4,287 1,788 2,643 4,893 0 2,000 4,000 6 ,000 8 ,000 1 0,000 12,000 Actual 2003 Actual 2004 Projection 2006 O thers Capital Expenditures Goods and Services W ages Others 8.3% 4.8% 3.5% Capital Expenditures 43.2% 55.5% 44.0% Goods and Services 35.3% 27.8% 38.5% Wages 13.2% 11.8% 14.0% Total 100% 100% 100% Notes: Financial data includes transfers, earmarked grants and donations. Source: Ministry of Finance. 1.43 Looking at the financing sources of capital expenditures, the bulk of investment in 2006 is planned to be financed from locally raised revenues. Not including foreign donations, only 24 percent of capital expenditures are expected to stem from government capital transfers, while the rest of capital is to be raised from own revenues and foreign donations. If revenues from foreign donations are counted towards capital transfer payments, about 31 percent of capital expenditures are financed by non-locally raised revenues. C. C OMPARISON OF PROJECTED FINANCIAL CAPACITY ACROSS MUNICIPALITIES 1.44 A close look at the projected municipal revenue and expenditure structure of the 84 local governments reveals several key differences. 1.45 The planned transfers imply considerable equalization of total revenues across large (secondary) and small municipalities. Depending on their revenue potential based on local economic activity, the progress in building local administrative capacity and tax effort, as well as the level of intergovernmental transfers, the municipalities’ financial prospects differ dramatically. Table 2.2 below shows the projection of total financial resources across municipalities in 2006, combined into four population size groups. First, the capital city of Skopje, comprising 10 municipalities, clearly outstrips all others in its financial capacity on a per capita revenue basis. The Page 45 22 average municipal budget per resident of Skopje is about 10,090 MKD (of which own revenues 7,888 MKD), whereas other municipalities dispose of per capita resources averaging 4,052 –4,584 MKD (1352-2287 MKD in own revenues). This can be explained by the naturally higher level of economic activity in the capital city, where local municipalities benefit from a stronger dynamic in the enterprise sector as well as in the construction industry. Table 0-2 Selected per capita municipal finance indicators, 2006 projections On a per capita basis total population # of munici- palities Category of municipality (# inhabitants) Total revenues Own revenues Total Transfers Capital expendi- tures % of which financed by transfers 506,926 10 Skopje 10,091 7,888 2,204 4,532 8% 674,168 9 Above 50,000 4,052 2,287 1,764 1,490 23% 664,025 33 10,000 to 50,000 4,182 1,645 2,537 1,897 43% 177,428 32 Less than 10,000 4,584 1,352 3,232 1,808 56% 2,022,47 84 National Average 5,655 3,398 2,257 2,381 24% Source: Ministry of Finance, own calculations. 1.46 Secondary cities with a population greater than 50,000 do not dispose of higher per capita revenues than other municipalities since there is a clear inverse relation between self-financing capacity and the degree of government transfers. While secondary cities are projected to raise own revenues of 2,287 MKD per resident, it is this group of municipalities that receives the lowest per capita transfers. The weaker level of economic activity in small municipalities, as well as their inexperience in revenue management, is reflected in their rather poor estimated own revenues per capita. The self financing capacity of the smallest municipalities is expected to be only 1,352 MKD per capita and their budgets depend largely on government transfers, which are the highest on a per capita basis (3,232 MKD). 1.47 The budgets of the secondary cities may, in fact, be too little relative to their economies —but judgment awaits their actual revenue-raising efforts in 2006 . Given the relatively weak financial basis of smaller municipalities, it is clear that governmental transfers are projected to play a significant redistributive role in 2006. However, the projections leave the group of secondary cities with the lowest overall revenues. It is too early to tell if this pattern was fully foreseen or whether it will continue. These secondary cities may also be able to exercise a stronger revenue mobilization effort than shown here. But if not, it could become an issue if these important regional centers suffer from seriously inadequate funding, which will impact their economic performance. 1.48 Regarding capital spending projections, the city of Skopje is again seen to have the highest per capita level among all municipalities, by far (4,532 MKD). The secondary cities with a population larger than 50,000 fall even further below the other categories in their capital expenditures (1,490 MKD), which are to be funded mainly by their own Page 46 23 resources. The self-financing capacity for capital investments varies significantly across municipalities. Capital investments in Skopje are almost entirely financed from own sources of revenues, while for small municipalities with a population of 10,000 or less, transfers are the primary source of capital finance, accounting for 56 percent. These shares of capital financing are as would be expected, at least at this prospective stage where the new decentralization framework is broadly intended to minimize major disparities in municipal expenditure outside the capital city. D. T HE M AIN ISSUES OF MUNICIPAL FINANCIAL MANAGEMENT 1.49 The next section discusses several key challenges that remain to be addressed in order for the financial decentralization process to be sustainable, that is, ensuring a strong revenue base, effective investment planning, and a sufficient institutional capacity. 1.50 Property Taxation. As of July 2005, for all three property-related taxes —the recurrent annual property tax, the transfer tax, and the gift and inheritance tax— responsibilities have been devolved for rate setting (within the allowed rate interval), assessment, billing and collection. It is expected that the transfer of property tax collection to local governments will improve collection efficiency due to the proximity of tax administrators and collectors to real estate objects and local knowledge of the real estate situation and changes, although the municipalities depend as well on the cadastre and land registration being updated through the Bank-supported Real Estate Cadastre and Registration Project. Local revenues are widely expected to improve significantly over the performance of the Public Revenue Office (PRO), previously in charge of collection. To achieve this objective at minimal costs, however, the municipalities require the full collaboration of the PRO. 1.51 As a consequence, municipalities are planning to increase significantly their property tax receipts and make the share of this tax more in line with the European proportions, although 40 countries demonstrate some 190 different ways of implementing local property taxation. (Brown and Hepworth 2002) Table 2.3 portrays the (un- weighted) average relative magnitudes of property tax revenue for the Central European transition countries, which are generally lower than those of the older EU members, with considerable variance as indicated by the figures for Hungary and Poland. 24 Although these proportions vary across the countries and change over time, the property tax appears a significant local government revenue source both in the EU-15 and in some of the Central European countries. 1.52 Comparison with Macedonia’s figures are highly tenuous. It is difficult to ascertain exact figures on the share of annual property tax in local government budgets, since data for 2003 and 2004 lump together all property taxes and the projections for 2006 represent a “composite” annual tax on both immobile and some mobile property. 25 Even so, the projections envisage that the composite annual property taxes will double 24 We use data from late 1990s for the advanced transition countries, since Macedonia is only now embarking on decentralization reforms similar to those undertaken by these countries in the second half of the 1990s. 25 Including taxes on motor vehicles (surface, air, water). Page 47 24 relative to 2003-2004 and provide 3.4 percent of local government revenues, which is roughly half of the average level in Europe. 26 Table 0-3: Property tax in transition countries Country/group % local tax revenues % local government revenues % general government revenues % of GDP Central European transition countries* (unweighted average)--EU8, of which: 14.3 6.9 1.6 0.6 Hungary 1.1 0.3 Poland 12.0 1.0 EU-15 countries 32.5 7.3 2.2 0.9 FYR Macedonia (2006 projected) 7.4 3.4 .004 .001 Refers only to recurrent annual property tax. Source: World Bank, 2001, “Reform towards Ad Valorem Property Tax in Transition Economies: Fiscal and Land Use Benefits”, Washington, D.C . Figures for FYR Macedonia from Table 2.1. 1.53 Property tax is potentially one of the most efficient local taxes: it is stable and predictable, and the revenues can be linked concretely and visibly to physical benefits linked to urban land uses and amenities. In Macedonia the fiscal significance of the annual property tax could increase considerably, as could its non-fiscal implications for land use (discussed in Chapter 4). Looking for growth in property tax receipts suggests first, several measures that municipalities can undertake themselves: (i) better discovery of taxable property, (ii) more effective tax collection and compliance, (iii) reassessment of tax rolls, and (iv) adoption of higher property tax rates. Central government is responsible for the most important reform needed —allowing more complete coverage through fewer exemptions. (i) Better Discovery of Taxable Property 1.54 The Law on Property Taxes requires municipalities to keep a register of real estate property subject to annual taxation (the fiscal cadastre). This registry is based on the original PRO property registry that was to be transferred to municipalities in 2005 27 , including software for producing reports based on both taxpayers and properties, showing such data as property address, taxpayer, tax status of property, property tax class, assessed value and identification numbers. The register becomes the record of tax 26 Some mayors suggest that revenues will be rising sharply – e.g. the Mayor of Strumica told the Bank mission that all property related taxes will produce close to 10 percent of all local revenues and 14 percent of own revenues. The Finance Ministry is more skeptical and was to review the dynamics of this change in mid-2006. 27 Full transfer only took place in the first half of 2006 . Page 48 25 obligations for a given year, and after changes during t he year, becomes the next year’s fiscal cadastre (property register). Many properties are not registered due to the slow clarification and updating in the property rights process. The ongoing Real Estate Cadastre and Registration Project aims to speed up resolution and registration of property titling issues. 1.55 Illegal construction, a significant phenomenon in some municipalities, cannot be registered and thus avoids (often purposefully) entry into property tax rolls. The de facto exclusion of illegal buildings from taxation (because they lack a registered title and are not recognized by the urban plans) further reduces property tax revenues. 28 The government might reconsider the possibility of taxation of illegal buildings, which are easily discovered and known to the cadastre. Some mayors reported that they are, in fact, assessing and billing the property tax on illegal housing. (ii) More Effective Collection and Compliance 1.56 Tax collection could be pursued more assiduously by local governments, which have assumed this function from the PRO. The transfer of property tax administration to municipalities has left many of them scrambling for quick fix solutions in 2006. Anecdotal evidence suggests that the PRO delayed the transfer of assessment rolls, billing and collection data, and also cut off interactive access to comprehensive tax administration software, leaving municipalities on their own to develop replacement software. In certain municipalities collection rates have been recently as low as 20 percent. 29 Smaller/rural municipalities were effectively forced to “contract back” the PRO for printing the tax bills at a price (6 MKD per bill plus reimbursement of paper and toner). A USAID project and ZELS (the association of municipalities) have mobilized assistance to these municipalities in the course of 2006, but the transition problems with PRO have created disruption of proper and timely tax administration, reflected in the weak expectations of tax revenues of some smaller municipalities for the current year. Comprehensive monitoring and audit of the collection process will be needed for at least a couple of years to ensure that the municipalities are able to adopt cost effective procedures. 1.57 Municipalities have been given strong authorities to garnish salaries and pensions and to seize moveable assets for non-payment of taxes, but it remains to be seen how effective they will use them. Better collection will also depend on the political resolve to increase tax compliance through positive information campaigns and demonstrated visible improvements to local infrastructure, so that the taxpayers perceive the linkage between property taxes and local services. (iii) Reassessment of Tax Rolls 28 Some of these cases have a legal title and building permit but are not in full compliance, e.g. in the construction of additions. 29 Based on mission interview with the mayor of Strumica, May 2006. Page 49 26 1.58 Taxable values largely date back to the self-assessments made in 1994 except in the case of properties that changed ownership since then, although municipalities now have authority to do spot revaluations. The Finance Ministry, as assisted by the USAID project, has issued comprehensive guidelines on valuation methodology to be pursued by municipalities. Applying the guidelines requires considerable local capacity, sufficient information support and payments for the work of valuers. These up-front expenditures would need to be covered by higher expected property tax revenues, which depend on better compliance and effective enforcement, and rate increases. These variables are highly dependent on the local political economy, including election cycles, and it remains to be seen how resolutely municipalities will pursue this process. 1.59 In many countries assessment services are provided at a higher government level to achieve economies of scale, assure consistency and cost effectiveness, and insulate the process somewhat from local political pressures. Developments in FYR Macedonia should likely move in similar directions and allow at least for cross-municipal pooling efforts and outsourcing to the core municipalities – much in line with the way construction permitting and building inspection is beginning to be shared. (iv) Increasing Property Tax Rates 1.60 The current legislation gives the municipalities the authority to set property tax rates, within a narrow range. Municipal councils can also adopt different tax rates for various categories of real property. The current Law on Property Taxes imposes an interval of 0.1 to 0.2 percent of market value. Anecdotal evidence in Macedonia suggests that municipalities have not even been opting to increase the annual property tax rates to the (internationally low) 0.2 percent limit allowed in the law. 1.61 In European practice rates differ widely, for example: · Finland -- 0.5 to 1.0 percent of market value and for domiciled property, 0.22 to 0.5 percent; · Denmark -- 0.6 to 2.7 percent, with almost 4 percent in the capital city; · Greece -- 0.3 to 0.8 percent of market value; · Latvia -- 1.0 percent of cadastral (market) value; · Portugal -- 1.3 percent of “notional market value”; and · Sweden -- 1.0 to 1.5 percent of market value. Numerous countries use tax bases other than market value: annual (rental) values, land and floor areas, book values (for buildings), indexed cadastral values, and point-system values. 30 Such alternatives may be of interest in Macedonia eventually, but in the short- to-medium term the municipalities should consider the scope for rate increases they have at their disposal already. (v) More Complete Coverage through Fewer Exemptions 30 Consequently, rates used on these tax bases cannot be compared to those applied on “current” market values as envisioned for Macedonia. Page 50 27 1.62 While the transitional handicaps to collection are being resolved, a more troublesome issue is that the central government has established numerous exemptions from property tax, which undercut the revenue potential for municipal governments. Property tax in Macedonia covers ownership (and sometimes leasehold) of non-agrarian land, residential buildings and flats, business space, administrative buildings, buildings and flats for leisure and recreation, garages and other structures. 31 However, the property tax law in Macedonia provides for numerous exemptions, including the properties owned by: (a) State, municipalities and City of Skopje (used for own purposes); (b) offices of diplomatic and international organizations; (c) National Bank; (d) religious communities; (e) businesses (used for own activity), except their administrative buildings/offices; as well as (f) cultural monunents; (g) facilities for conservation of land, water and air; (h) agricultural buildings; (i) housing in mountain regions as declared by the Government; (j) properties used for job training, professional rehabilitation and disabled persons; (k) land used for mining and geological exploration; and (l) land used for agricultural production. 32 In addition to these statutory exemptions there is a so-called residential preference, whereby property tax is reduced by 50 percent for occupied domiciled properties. Moreover, developers are exempt from the transfer tax on the first sale of flats, which represents a subsidy for developers. 1.63 The exemption of own-use commercial buildings and land (except administrative buildings/offices) is very unusual in international practice, and constitutes a big potential revenue loss for the local governments. Taxation of non-residential property typically generates more revenues than residential taxation, and the FYR Macedonian case is probably without precedence in other market economies. Typically, business buildings and premises generate a high proportion of property tax revenues in other European countries. 33 While some other measures tend to implicitly act as a quasi-property tax on nonresidential property — namely “signage fees” charged to businesses according to schedules differentiating among use types and location — these are much less efficient than broad based, value-calibrated property taxation. 1.64 Finally, a word of caution is needed regarding optimistic expectations about revenue potential from property taxation in Macedonia, given comparative review of transition country experience with property tax reforms. This history suggests that fiscal decentralization relying on local governments readily opting to use property tax more intensely may fail to meet central government expectations, as local politicians try to soften taxation of their electorate (direct accountability) and continue to request higher transfers from central government (indirect accountability), while preferring to sell off their assets, which is politically less “risky”. This suggests that the main thrust of property tax reforms should come from the central government, but the recent experience 31 Property tax covers also enumerated categories of movable property such as larger motor cars, buses, freight trucks, tractors, combines, vessels and aircraft. 32 In addition, the inheritance and gift tax is set from 2-5 percent of the value, but exemptions allow for considerable loopholes to revenues. For example, a first order of succession is exempt from the gift and inheritance tax regardless of the value of the inheritance. A limit on the value of the exemption would ensure that rich citizens pay a share of the inheritance. Government and municipal officials (and other social institutions) are exempt from inheritance and gift tax. 33 In Poland, for example, business rates per square meter are 35 time higher than the residential ones, which explains why some 80 percent of property tax revenues derive from this property category (which treats own-business and rented property equally – unlike in Macedonia). Page 51 28 with the PRO does not raise good prospects. Another issue to be considered is whether the non- taxation of business p roperty gets “capitalized” into higher real estate prices and thus lower profitability. As noted, businesses get “taxed” implicitly through signage fees, and through taxing office floor space used for business. This highly unusual “proxy” of property taxation calls for separate examination to determine the incentive effects, impacts on the real estate market, and opportunity costs to local government revenues. 1.65 Municipal debt. The debt inherited by some municipalities from the previous local administrations (prior to the decentralization) remains a sensitive topic, particularly in the cases of municipal mergers. Though the Law on Financing Units of Local Self Governments set December 2004 to resolve arrears (for debt accrued before 2001) as a condition for moving on to Phase Two of the decentralization process, end-2007 has now become the target date for possible removal of the debt moratorium. Until then no new debt shall be accrued by municipalities. The conditions for declaring the debt resolved, particularly 24 months of good financial results, may be difficult for some of the municipalities to meet. Reportedly, as of end of 2005, with only 39 municipalities reporting (accounting for about 60 percent of the debt), the stock of municipal debt had decreased between 16 and 24 percent. The situation is highly varied with some municipalities having no indebtedness or having paid it off, while a few others are nearly insolvent and reportedly would need 7-10 years to repay (assuming annual debt service limited to 15 percent of current revenues), according to ZELS. 1.66 The law on Financing Units of Local Self Government is clear on limiting local government borrowings and establishes the firm position (correctly) that the central government will not bail out local governments that borrow irresponsibly. Further, the Ministry of Finance has affirmed that it will not absorb any of these debts except for the small portions of interest owed to the national electricity company and to expropriation debts. This is a commendable approach that gives the right signal to both municipalities and creditors, and sets hard budget constraints on municipalities to instill in them the necessary financial discipline. 1.67 The bulk of the municipalities’ debt (about two-thirds) is owed to a few, and mainly to one, construction company, Granit (formerly public sector owned). The construction creditors have been successfully suing the local governments and garnishing tax revenues. However, there are serious questions about the non-transparency of many of these construction contracts concluded in the pre-decentralization period, at a time when public procurement laws did not require property fiduciary controls. While there is no question of simply writing off the debts, the accumulated debt problems reflect in part past shortcomings in the central government’s oversight and the noncompetitive practices by a dominant public enterprise at the time. It may be appropriate for the central government authorities to help the smaller municipalities in negotiating feasible repayment terms with the major creditor, if necessary. At present, the government has taken the position that any rescheduling has to be negotiated by the municipalities themselves with their creditors. 1.68 Resolving the past municipal debt problems in a sustainable manner and ensuring a healthy balance sheet will depend in part on decisions in two areas of policy. The first Page 52 29 concerns the question of municipalities’ financial participation in sales of construction land in their jurisdiction. The question of municipal land ownership and management is discussed at length in Chapter Four. Revenues from sale or lease of land within a municipal area now accrue only to the national government. 34 While some future revenue from taxes and fees would accrue to municipalities, this is hardly sufficient to service and maintain the land, and the length of time it takes for the procedure to be completed is not commensurate with the urgency of local government finance requirements. For local governments to actively participate in land management and urban development, their financial interest in the land in their territory should be recognized. An agreement on sharing the proceeds would need to be reached while debating the full ownership of land. Proceeds could be earmarked for specific municipal activities, including debt relief or upgrading of communal services, in agreement with the national government. 1.69 Second, the municipalities’ future financial health is tied to that of their communal services enterprises. Municipal governments may borrow on behalf of, or guarantee loans to, public enterprises. 35 Previous national government policies, such as the freezing of communal service tariffs for about 10 years, have put the communal enterprises in a distressed financial situation, requiring support from municipalities and leading to delayed investments and increased repair and maintenance delays (discussed in Chapter Three). Reforming the commercial viability of the communal services enterprises will be a key element in preventing pressures for new explicit or contingent liabilities of their owner municipalities. 1.70 Investment planning and selection. The central government currently provides several capital grants and transfer windows to finance municipal investment projects. The magnitude of these funds is difficult for the individual municipalities to foresee, however. The major categories of central government investment transfers include: · transfers from the ‘budget of the fund’, which are largely used for road rehabilitation and construction. The distribution criteria take into account the length of the municipal road system and the transfers do not require a matching portion; · capital grants from the MOTC, mostly used for water supply and sewerage systems, which tend to require counter-financing by the municipality and are meant to cover the costs exceeding the financial capacity of municipalities; 36 · transfers from the Fund for Undeveloped Regions. 37 34 The municipalities are permitted to own and sell buildings, and many have done so in part to pay off debts. 35 There does not appear to be a law on borrowing by communal services enterprises . If municipalities are expected to borrow on their behalf (when their own debt moratorium is lifted), this situation will require very close monitoring. 36 To access capital grants municipalities are required to draft a comprehensive financial breakdown of a proposed project which needs to be approved by the government. At this point it seems there is no established methodology for allocation of these funds to municipalities. For 2005 municipalities submitted requests equivalent to 3.2 billion MKD and received 0.15 billion MKD. 37 By the law the fund should have a budget equal to 1 percent of GDP, but usually their budget is only around 0.1 billion MKD (about 0.03 percent of GDP) Page 53 30 1.71 Proposals for local infrastructure investment, including for the communal service enterprises, are submitted by the municipality, which is responsible for the assets. However, municipalities and enterprises rarely prepare multi-year investment and financing plans, resulting frequently in unfinished projects. Criteria for acceptance of proposals by the MOTC (to the Road Fund and funds for communal services-related investments) are largely technical and based on whether preparatory documents and permits are ready. Financial and economic analysis of proposals and alternatives are rarely prepared. These ministry funds fall well below requests, so they are spread among the municipalities without apparent strategic prioritization. 1.72 The training municipalities have received in strategic planning is increasingly taking a more integrated approach, to incorporate budget planning. Many have also been trained in participatory planning and budgeting methods, notably under the Bank’s Community Development Project. But the incentives for municipalities to actually do multiyear investment planning seem weak, given the above process for approval of proposed projects. 1.73 As for investment planning pertaining to future EU funding, the recent progress report of the EU Commission (EU 2005) stressed the necessity for FYR Macedonia to put the administrative capacity in place to ensure a smooth implementation of EU structural policy. Up to now there is no clear framework that defines the role of local governments in the future management of structural and cohesions funds. There are concerns about the lack of readiness of municipalities to undertake medium-term planning and investment selection. The administrative capacity at the municipal level differs significantly, with a large number of small municipalities likely being most unprepared to undertake structural fund programming and implementation as well as to mobilize required counterpart funding. E. S TRENGTHENING INSTITUTIONAL PERFORMANCE AND ACCOUNTABILITY 1.74 The Law on Local Self Government clearly holds municipalities responsible for the performance of functions of local interest, but creating an environment where this performance can be assessed and the municipalities held accountable requires explicit efforts. The legal framework calls for public consultation and provides for financial audits, but wider and deeper openings to citizen involvement and to public scrutiny of government activity are important to create full trust and understanding—and to avoid risks of corruption, which can be just as endemic in local government as in central government. 1.75 Performance monitoring. Several new initiatives are underway to collect data on municipal activities, for various purposes. The MLSG working groups on decentralization have started conducting quarterly surveys of all 84 municipalities to gauge attitudes and identify problems. EAR is supporting two new data gathering efforts: a) pilot testing of a "municipal monitoring system" initially in 4 municipalities, focused on 75 indicators in 10 areas of municipal management, and b) collection of data relevant to urban planning functions (such as number of new plans, building permit applications and approvals, etc.). Both of these exercises are intended to encourage Page 54 31 monitoring that municipalities can do on their own and are not intended for comparative assessment, which was characterized as "politically sensitive". So far it is not clear which of these approaches may be sustainable either by the municipalities themselves or by central government, but they reflect a wide awareness of the need to gauge their performance. The amount of data available as inputs to any of these efforts was reportedly limited by a lack of suitable breakdown of statistics from central government agencies and lack of coordination among central and local governments. 1.76 Although public comparisons of the performance of local governments may be resisted, it is important that monitoring be seen as a necessary element of good governance and essential to an informed electorate, as well as to informed policy makers and service operators. On municipal budgets the law requires the submission of monthly reports by budget users to the mayor. The mayor is required to submit quarterly reports to the MOF on budget performance, and to make these reports available to the public. The State Audit Office is required to perform regular annual audits of all municipal financial statements. It will be useful for the central government to formalize or standardize performance measurement by the local governments in other areas besides budgeting, and ultimately to require that such information be made publicly available. It would also be worth using performance indicators in the determination of eligibility for some fiscal transfers and capital transfers. 1.77 Public participation. The Law on Local Self Government defines public information and citizen participation as a process of appeals and receipt of citizen proposals. Municipalities are divided into urban communities (in cities) and neighborhood communities (in other populated areas), and the role of citizen participation is defined for these communities. Mayors can delegate functions and their financing to them. In practice, much of what passes for public participation is really consultation after-the-fact, e.g. presentation of draft urban plans for public review rather than seeking public input at the outset of the process. There is considerable experience in some municipalities with more proactive involvement of citizens and community-based organizations in planning and decision-making, promoting citizen initiatives, especially in the context of some donor-supported projects. These experiences should be supported and expanded, with the encouragement of the central government if necessary. 1.78 Training and capacity building. Macedonia has a long tradition in local government management and service delivery, stemming from the Yugoslav era. But specific skills and experience were lost during the recentralization of the last decade. A USAID- sponsored “capacity index” assessment 38 found that about half of the municipalities scored below 10 percent of the maximum score. Capacity building has 38 The municipal capacity index is part of research done for the USAID Making Decentralization Work project. It measures municipal capacity in areas such: municipal management and financial management; municipal tax administration; transparency and citizen participation in decision making; public records, urban planning, and regulatory management; and provision of more accessible, convenient and customer-oriented services. Each category contains four sub-categories. The capacity index employs a scale of 100 points and weighs all five categories equally (up to a maximum of 20 points each, 5 points maximum for each sub-category). Of the five fields the lowest average result was found within the tax administration department. Page 55 32 been needed to focus on upgrading/modernizing skills especially in the newly transferred competencies, and developing practical solutions for service provision in the smaller/newer/poorly resourced municipalities that may be unable to perform and finance many functions on their own. Further, the local governments are still unfamiliar with practices to establish accountability to their constituents and a climate of trust through active communication and participation strategies as noted above. 1.79 The MLSG has initiated a program of capacity building of the municipalities and is overseeing several donor-supported training initiatives. Considerable support in budgeting and financial management has been provided to municipalities by several donors, including the Bank through the Community Development Project, and USAID. EAR and USAID have also delivered focused training on urban planning and construction permitting, and sophisticated IT/GIS equipment has been transferred to all the municipalities. Strategic planning initiatives have been sponsored by several of the donors as noted in chapter 1. Therefore, most of the municipalities are quite aware of what kinds of management approaches and tools they could or should be using, but they have little practice and limited staff. A key gap is assistance in pilot exercises to apply and implement the good management and governance methods that have been taught . 1.80 Despite considerable efforts, serious challenges in fiscal decentralization remain. While the government has started to train staff and strengthen the public financial administration it seems that many small municipalities, finding themselves confronted with an enlarged set of responsibilities and competencies, do not yet possess the institutional and resource capacity to cope with these new challenges. Clearly this lack of administrative resources is not limited to issues of financial management, but further training of municipal finance department staff has been identified as a key priority (IDSCS 2006). 1.81 Cooperation and voluntary association among municipalities. Although the overall number of municipalities was reduced with the recent decentralization process, small municipalities will be unable to undertake the full array of administrative responsibilities without some sharing of efforts with others, to exploit economies of scale and compensate for shortages of staff and facilities. 39 Although collaboration to share services such as tax collection and building inspection is starting, aided by UNDP and USAID projects (Box 2-1), indications are that it may move slowly. Ethnic sensitivities across boundaries in certain cases, some municipalities' fears of losing newly won independence, and lack of information on alternatives are possible obstacles to cooperative action. Greater exposure to good practices through international organizations of local governments, such as the United Cities and Local Governments (UCLG) based in Barcelona, Spain, may help provide concrete examples of the efficiencies that can be gained by inter-municipal collaboration in specific functions, and help overcome such resistances. 39 A study done prior to the recent decentralization (Nikolov 2004), based on the revenue structure of 123 municipalities, estimates increasing economies of scale up to a municipal population size of 6,000. Page 56 33 Box 0-1 The current practice of municipal collaboration in FYROM The possibilities for establishing joint or shared municipal administrations, granted by the Law on Local Self-Government 4 0 , have already led to several cases of municipal cooperation. One approach is joint administration. A number of municipalities jointly contribute their human resources and related technology to perform certain tasks. They also share costs and respective revenues on a derivation base. Currently, the only extensive joint-administration is that of Novo Selo, Bosilovo and Vasilevo. These three municipalities in the Strumica region have established a joint-administration for urbanism services (e.g. administration of construction permits), inspection (in construction, communal enterprises, etc.) and tax administration. The joint tax administration service is located in Vasilevo, the urbanism administration in Novo Selo, and the inspection services in Bosilovo. Citizens still apply for the particular service in their own municipality. The application is subsequently transferred to the municipality where the joint administration is established. As a further example of limited cooperation, the rural municipalities of Krivogashtani and Dolneni have hired a person who administrates the urbanism related services for both municipalities. A second form of cooperation is the outsourcing of municipal services to typically larger municipalities. Depending on the nature of functions, municipalities either provide a service when called upon or permanently take on the administration of a specific service. An interesting case is the contract between Veles, Chaska and Lozovo. The municipality of Veles provides inspection services, technical assistance in internal auditing issues and other financial management issues. After a call for service from Lozovo or Chashka (e.g. for inspection services), Veles inspectors visit the municipalities and perform the inspection in the presence of municipal staff of Chaska or Lozovo. Based on prior fee agreement the municipalities will then pay for the service. 41 A more frequent form of outsourcing can be found in the permanent provision of services by larger municipalities. Several municipalities use cooperation to outsource their tax administration (Veles cooperates with Chaska, Bitola with Novaci, Kavadarci with Rosoman and Tetovo with Bervinica) . F. C ONCLUSIONS 1.82 The Macedonian municipalities convey a high degree of optimism about their increased financial autonomy, a promising sign that they will exercise new efforts to mobilize greater revenues, thus permitting better service delivery to their constituents. There are, however, major issues in the design and implementation of the property tax. Reform of what is potentially the most productive local tax will require leadership by the central government, and more support to the municipalities than has been forthcoming from the PRO in the first year of devolution. The central government has indicated the 40 Inter-municipal cooperation is regulated in Article 14 as follows: (i) In the performance of their competencies, the municipalities may cooperate among themselves; (ii) For the purpose of accomplishing common interests and performing common tasks that fall within the competency of the municipalities, they may join funds and establish shared public agencies, in accordance with law; (iii) For the purpose of performing certain competencies, the municipalities may also establish shared administrative bodies in certain areas, in accordance with law; (iv) The municipalities may cooperate with units of local self- government of other states, as well as international organizations of local communities, and may be members of international organizations of local governments; (v) The ministry responsible for the performance of functions related to local self-government shall keep records on the realized international cooperation of the municipalities, in accordance with law 41 It is worth mentioning that the Municipality of Lozovo is not an adjacent neighbor to Veles. Page 57 34 intention to effect considerable equalization of resources across the municipalities through transfers, but it is also important to ensure that the secondary cities have adequate resources to perform their role as regional economic centers. The fiscal transfer system should take account of the fact that some localities will continue to have greater economic potential and impact than others; fiscal transfers should therefore not simply help all municipalities survive but rather foster centers of economic dynamism for the benefit of the whole country. There remain major issues of capacity particularly in the small/rural municipalities, for which voluntary association may be a very practical solution. The financial viability of the municipal governments will also be affected by the circumstances of the public enterprises they own, discussed in the following chapter, and by policies and practices in urban land management, which is the focus of the final chapter. Page 58 35 Communal Services 1.83 Communal services, particularly water and sanitation, solid waste management, public transport, and other urban infrastructure services are among the most important responsibilities of local governments. They contribute directly and indirectly to economic growth, household welfare, and environmental sustainability. Macedonia has relatively well developed communal services and the challenge is to maintain and improve them, in part as one of the requirements of Macedonia’s bid to join the European Union. 1.84 The upheaval the country faced in the last decade contributed to making this task even more difficult. It led to years of unmet demand for maintenance of infrastructure networks as well as to policies of price control that further inhibited the ability of municipal governments and enterprises to generate necessary funds for routine operations and upkeep, or for new investments. Discussions with government officials both at the local and central levels, as well as with municipal enterprises and donors, reveal a common awareness and frustration with a wide set of issues concerning the performance, financing and institutional set-up of the communal services enterprises. The present chapter reviews these issues that are central to improving the performance of the urban economies, addressing urban poverty, and ensuring that municipal governments can meet their commitments to sustainable provision of good quality services. G. T HE STATUS OF LOCAL INFRASTRUCTURE SERVICES 1.85 FYR Macedonia is poorly represented in cross-country studies and databases on infrastructure (other than electricity and telecommunications), because of the limited public availability of data especially on service quality, reliability and affordability. Very little information even on water supply service and consumption is included in standard statistical publications. The household budget surveys ask only about access (whether the household is connected) to water, sewerage, electricity and has a telephone. The results indicate that formal connections are quite widely available even to the poor, except for sewerage and district heating. 42 (Table 3.1) Table 0-1 In-dwelling connections to infrastructure (percent of population) National average Non-Poor Poor Water supply 93.7 94.9 89.4 Sewage disposal 74.8 77.8 64.0 Electricity 99.4 99.5 98.9 Central heating 10.1 11.9 3.6 Telephone line 90.0 93.3 78.1 Source: Household Budget Survey 2003. Table from World Bank 2005a. 1.86 Whether the services are satisfactory and affordable is impossible to determine from available survey data. However, it is worth noting that at least in 2001 household 42 It should be noted that district heating and piped sewerage are only economically viable in densely populated settlements, and that good alternatives (e.g. electricity and septic systems) can exist for other circumstances (e.g. periurban and rural areas). Page 59 36 expenditures on housing and communal services combined were reported to be 11.3 percent of total household expenditures, significantly below the 16.5 percent reported on average by the EU-8, Romania and Bulgaria, but above CIS countries which averaged well below 10 percent. (Estache and Gassner 2004) World Bank estimates on the basis of 2003 HBS data indicated spending on housing and utilities averaged 10.2 percent of total household expenditures, ranging from a high of 12.8 percent in Skopje and only 3.1 percent among the poor. (World Bank 2005a) Whether these rates indicate that households are conserving on the consumption of infrastructure services, are not being charged, or are simply not paying for them, is not clear without a detailed user investigation. 1.87 The brief survey of the largest municipalities undertaken for the 2004 Urban Policy Note found quite a large variation in provision, especially of roads and sewerage . The subsequent survey of substandard settlements (see Chapter 1) and further qualitative analysis found that safe wastewater disposal at the household level is particularly lacking in the substandard settlements, some of which are served only by standpipes. Many urban areas have no wastewater treatment. Wastewater treatment investments have been identified in the national investment plan but so far, few have been affordable especially given the problems of water system management as outlined below, which weaken the utilities’ financial viability. District heating exists only in Skopje and one secondary city. There is considerable use of solid fuels by households in many locations. According to the 2003 HBS, a remarkable 80 percent of the population nationally heats their homes with stoves using solid fuels (78 percent of the nonpoor and 89 percent of the poor). Solid waste disposal is also very inadequate. There are almost no sanitary landfills outside of Skopje. A report by the State Communal Inspectorate of the Ministry of Transport for the period 2002-2005 concluded that without exception, the disposal of municipal waste (including hazardous waste) is an unmitigated disaster in all municipalities. Page 60 37 Table 0-2: Infrastructure Coverage in Major Cities in Macedonia Municipality 2002 Population City Road Infrastructure % coverage City Water Supply Network % coverage City Sewerage Network % coverage Skopje 476,727 50 85 74 Kumanovo 104,344 83 86 77 Bitola 87,652 67 84 72 Prilep 74,065 70 90 75 Veles 57,844 80-90 98 95 Ohrid 54,839 75 100 60 Gostivar 49,657 50 90 60 Stip 48,098 90 80 70 Strumica 45,213 65 65 60 Source: Survey of 14 largest municipalities (over 30,000 population) taken in 2004. Those that did not respond regarding infrastructure coverage (mainly the smaller ones in the sample) are not listed here. (World Bank 2004) H. L EGAL AND INSTITUTIONAL ISSUES IN THE COMMUNAL SERVICES SECTOR 1.88 Local public services (water and sanitation, public transport, public lighting, heating, street cleaning and parks, marketplaces, cemeteries) are provided in Macedonia through municipal-owned enterprises. In most cases a single enterprise covers all these functions, although a few of the larger cities have separate water utilities. There is no private sector participation of any significance. Two donors, KFW/GTZ and EBRD, have been the main providers of external investment finance and have attempted, to varying degrees with uneven success, to promote financial and institutional reforms in the utilities they support (three by KFW and five by EBRD). Although the communal public enterprises are legally independent companies, in fact they are heavily dependent on the municipalities and influenced by them politically, so that ownership, tariff-setting, and operation responsibilities are intertwined. There seems to be little commercial orientation or effective pressure for it. Not all of the utilities use international accounting standards. 1.89 The State Communal Inspectorate of the Ministry of Transport, in its latest inspection activity for the period 2002-2005, found mounting challenges: inadequate financing and collections, fragmentation in sources of funding, high outstanding VAT obligations, dependence on inefficient court procedures, general inefficient management Page 61 38 of enterprises, and numerous instances of noncompliance with new regulations. The study also found that the political influences are considerable and deter efficient operations of the communal enterprises. Poor relations between municipalities and their communal enterprises manifest themselves in municipalities not paying their obligations and transferring unfunded mandates to the responsibility of enterprises, particularly in maintenance of public areas. The appointment of managers by the mayors and municipal councils leads to various political tensions, impacting pricing decisions and work programs, thereby putting enterprises in a more difficult financial situation. The study recommends commercializing the communal enterprises and eliminating political influence by differentiating the authority and obligations of municipalities and their enterprises. The problem of non-collection was also identified as needing resolution, particularly for the “social cases”. 1.90 The Association of Finance Officers of the Local Self Government and Public Enterprises, with USAID financing, undertook a detailed survey of 49 municipal enterprises in July 2004, as part of technical assistance to the Ministry of Finance. Their report reiterated the numerous problems faced by municipal enterprises, including low prices of communal services, low collection rates, debt and arrears, obsolete equipment, large “social cases”, inefficiency of courts, and other legal constraints. 1.91 The Association of Municipal Communal Enterprises (ADKOM) and the Association of Financial Officers, with the assistance of donors, have started a very important exercise of collecting basic indicators on enterprise efficiency and financial performance for a considerable number of enterprises. The database is still incomplete and of uneven quality, but once improved it could be used for further analysis. Consistent support for this exercise would yield long term and comparable data that could assist policy makers in arriving at well founded decisions for shaping the future reform and development of communal enterprises. Comparing indicators across utilities could contribute to raising awareness among politicians and the general public, and create some pressure among all stakeholders on the need for reform. 1.92 Discussions with stakeholders including national and local government officials, donors, NGOs and enterprise staff and managers, coupled with a review of the above mentioned studies, reveal several major institutional problems prevailing in communal enterprises as outlined below. The dominant financial issues are discussed in the next section. 1.93 Nontransparent accounting for combined communal services. Almost all communal services in Macedonia are provided by public enterprises, wholly-owned by the municipalities, that provide a combination of services (water and sanitation, sewerage, solid waste collection, cemetery services, parks and public lighting, drainage, public transport, etc.). Bills sent to households include all items. This set-up is expected to save on overhead and administrative costs, by sharing common administrative, financial and repair services across the sectors. However, the situation also encourages internal cross subsidies among the services and makes it more difficult to determine the financial situation or needs of each. It therefore discourages a commercial orientation in the management of the revenue-earning services. In addition, communal enterprises are Page 62 39 burdened with responsibility for some non-revenue activities such as park maintenance, for which they get little or no compensation from the local government (e.g., the Skopje water utility, one of the few separated institutionally from other services, is required to give 22 percent of its water to the parks unit). 1.94 In most European countries water supply and sanitation in cities and large towns are provided through companies dedicated to that activity, while the provision of local public goods, such as park maintenance, street lighting and drainage, is managed separately and their costs covered through taxes. Donor support to certain communal services enterprises has required them at the minimum to have clear cost centers to allow for a better picture of the financial position of the various activities. In some cases, separate enterprises for water and sanitation services were established —e.g., in Ohrid and Struga, which are served together by a single water utility. 1.95 Combining tariff-based and non-tariff-based services in one enterprise can be a reasonable practical solution for small municipalities. Some activities, such as solid waste collection and cemetery services, could be outsourced to the private sector. But at minimum, efficiency requires separation of accounting for different types of services, transparency in cross subsidization, and adequate tax-based funding for public good-type activities. These conditions would also be necessary to attract potential private sector participation in any of the services. 1.96 Weak and contradictory regulatory framework . New or recently revised legislation governing the communal services sector includes: the Law on Communal Activities (1997, amended June 2002), Law on Public Enterprises (last amended in 2003), Law on Drinking Water Supply and Outflow of Urban Wastewaters (2004), Law on Waste Management (2004), and the Law on Communal Fees 43 (2004). The law on public enterprises requires communal enterprises to act on a commercial basis, yet the same law gives broad authorities to local government in the financial and management operations of the enterprises, weakening their independence and commercial orientation. The right of the mayor to appoint the management of enterprises leads to considerable political influence at the expense of efficiency. The elected local council also has a strong hand in the operations of public enterprises. It appoints members of their boards, adopts financial and work programs, reviews budget reports, and issues permits for performance of activities of public interest. The ability of the local government to reallocate resources or profits from one enterprise to cover losses of another or to pay obligations to central government is a further detriment to the commercial orientation of communal enterprises. It undermines the correct incentive to managers and employees to improve efficiencies, when they know that any savings they achieve may be diverted to other non-performing enterprises. 44 43 Sometimes translated as “utility fees”, this law, despite its confusing title, does not concern tariffs for public enterprises services, but rather taxes and fees imposed by the municipality for items such as business signs and sidewalk space used by commercial establishments and restaurants. 44 The Law on Public Enterprises allows the founder to invest surplus incomes in the enterprise or in other public enterprises to cover losses, or for securing obligations of the budget. The Local Government Finance law defines utility fees and charges for communal enterprises as sources of local revenues (without Page 63 40 1.97 The Law on Financing of the Units of Local Self Government considers utility and communal fees as revenues for local governments. While laws require the government to compensate public enterprises for obligations mandated by it, this is not practiced fully or consistently. For example, as mentioned, the independent water supply and sanitation enterprise of Skopje is not paid for water provided to parks and public areas. Other enterprises are required to perform unfunded mandates such as cleaning of public areas, parks and streets without compensation. 1.98 Overemployment and misbalanced skills. Overemployment remains a problem in Macedonian communal enterprises. In 2001, it was estimated that the share of employee costs is about 60 percent of total utility expenses, as compared to 25 percent in well-run utilities in western Europe. The appraisal document of the World Bank project approved around that time (but cancelled before effectiveness) reported that staffing in Macedonian utilities was about 3-4 times higher than in western European utilities, per number of connections. According to enterprise managers interviewed for the present report, staffing has not changed significantly since 1991. On the contrary, the proportion of administrative staff has increased at the expense of maintenance staff, due to a personnel policy driven by political considerations and pressure from local and national governments. I. M AJOR FINANCIAL ISSUES AFFECTING THE COMMUNAL SERVICE ENTERPRISES 1.99 High water losses . Surveys indicate that unaccounted for water (due to technical losses in the system and administrative failures in billing) in Macedonia amount to about 40-50 percent of water produced. Costs are incurred to produce this water, including high electricity costs for pumping and water treatment. Donor and government financed investments are ongoing in few municipalities to address this problem. This loss represents a cost in production of water that has to be recouped from paying customers. Macedonia seems to share similar high losses with other Balkan and former Soviet Union states, but it lags behind Latvia, Lithuania and other well-performing European utilities who contain losses to around 20 percent. 1.100 Low collection rate . Experts estimate that the collection rate country wide is about 50 percent of billed communal services. A persistent environment of non- collection leads to decreased payment discipline and deprives the enterprises from generating internal funds for needed investments. Non-collection is a hidden, untargeted subsidy to those who do not pay. Allowing this to continue is unfair to the paying customers and leads to depletion of assets through lack of repair and maintenance. The law clearly sets conditions for termination of service due to illegal connections and non- payment regardless of status, yet it appears that many municipalities tolerate non-payers either as a political gesture or as an implicit social subsidy. In Skopje, a dedicated campaign to improve collections raised the collection rate to 80 percent. The campaign included efforts for public information, improved services, and increased on-site much elaboration). Both provisions are clearly detrimental to commercialized activities and are disincentives to private sector participation. Page 64 41 collections, combined with serious efforts to cut off non-payers. Some municipalities were able to take concrete actions with regard to cut offs, while others cited many difficulties with the procedure. Cases may revert to the courts, but these procedures are lengthy and costly, resulting in the recovery of numerous small amounts at high legal costs. 1.101 Stagnant tariffs . The national government imposed a freeze on tariff increases from 1994 to March 2005. Only a few communal enterprises receiving assistance from foreign donors were allowed to increase tariffs to satisfy conditions for donor support. At the same time, inflation and input prices, notably of energy, continued to rise, while staffing remained at the same levels. This situation diverted scarce resources from required system maintenance to pay for daily operations, leading to further deterioration of the system and a backlog of capital repairs and investment needs. Low tariffs, below costs, are a form of general untargeted subsidy to the whole population and very costly to the economy. 1.102 The average water tariff in Macedonia 45 is currently the 10 th highest (tying with Romania) in a list of 27 countries in the Europe and Central Asia region. (World Bank 2006b) However, the list includes nine countries where the fee is less than US$0.10 per cubic meter. Macedonia has the lowest charge among recent EU members or those aspiring (e.g. Estonia US$1.22, Bulgaria $0.59, Croatia $0.71 per cubic meter). The World Bank’s estimate of a cost recovery tariff in the SEE region, which could be used as a rough benchmark for Macedonia, is US$1.00 per cubic meter—in contrast to the current tariffs in most utilities between US$0.24-.51 per cubic meter. Generally, communal enterprise managers indicated that they would need to double the current tariffs in order to feel financially “safe”. Improving collections would also go a long way to improving the financial situation of enterprises, while mitigating the risks of runaway increases in tariffs. 1.103 Unrealistic accounting treatment of communal enterprise arrears . Although FYR Macedonia encourages the use of international accounting standards and aims, in some of its legislation (e.g. on methodology for determining service tariffs) to use advanced concepts such as revaluation/replacement of assets, it also employs selectively the old accounting procedures. This applies to the treatment of arrears, whereby communal enterprises cannot easily write off their arrears in accordance with generally accepted accounting principles. In addition to requirements for long procedures, it was reported that penalties apply for writing off arrears. Communal enterprises that received foreign support are required (e.g., by EBRD) to report their accounts based on international standards and they show the effect of write offs. It is clear that accounting treatment of arrears does not solve the non-collection problem, and the only means to correct that situation is to improve collection through enforcement of the laws. 45 Water tariffs are currently MKD 27.07 (US$0.56) per cubic meter for households and MKD 39.89 (US$0.83) per cubic meter for businesses, for the five communal enterprises that have EBRD loans; the tariffs are MKD 11.73 (US$0.24) and MKD 24.25 (US$0.51) per cubic meter, respectively, for the other utilities . Page 65 42 Recognition of non-collectibles from bankrupted companies is necessary to clear the financial situation of enterprises that are expected to operate on a commercial basis. 1.104 The July 2004 survey of 49 municipal enterprises undertaken by the Association of Finance Officers 46 (with support from USAID) gave particular attention to analyzing the arrears carried by the municipal enterprises (debts owed to them) in terms of sources and age. The largest debtors are other legal entities (54 percent), many of which are already bankrupt and which had been state owned enterprises; physical persons (39 percent) most of whom are considered “social cases”; and budget organizations (five percent). Arrears over one year total 1.6 MKD billion, of which 44 percent are over three years old. Claims brought to court amount to 646.4 MKD million, out of which about 40 percent was collected. The percentage collected from legal entities through court procedures appears high at 94 percent, while collection from physical persons amount to only 17 percent. Although enterprise arrears constitute the majority, a smaller portion of enterprise arrears are subjected to lawsuit in comparison to arrears from physical persons. 1.105 Debts of the communal enterprises themselves . Long term debt of communal enterprises is important for municipalities as well as the enterprises, since it represents a contingent liability of the owners. A debt burden also affects the utilities’ potential attractiveness to private sector investors. The same 2004 survey of 49 municipal enterprises contains data on their outstanding debts, but combines short term with long term liabilities. Commercial bank credits and credits from international organizations, or long term debt, represent only about 20 percent of total debt. This might mean that enterprises rely on short term debt, i.e., not paying creditors and tax authorities, to finance their operations. A prolonged situation of non-collection and low tariffs would lead to non-payment of liabilities. The long term debt appears to be concentrated in only sever of the 49 reporting municipal enterprises (in addition to the four borrowing from EBRD), indicating very little use of long term debt. 1.106 Total debt of the reporting enterprises in the survey amounts to 1.2 MKD billion (or about $0.5 million per enterprise), of which 53 percent is for creditors. Credits from commercial banks are about six percent, and the EBRD loans to four utilities account for 15 percent of the credit total. About 14 percent of the credit is payable to staff and 12 percent is due for taxes (the majority of which is for VAT arrears)—categories normally considered short term debt. About 67 percent of this short term debt is cleared within the same year. 1.107 More analysis could be done on debt ratios, and on general debt and operational management (e.g. number of employees per size of municipalities) could be undertaken. However, the data are not fully transparent since short term and long term debt are not separated, and it is not clear whether interest payments are included and how. Because of the combination of services, some assumptions would have to be made and verified. While it is difficult to draw general conclusions, it is notable that eight out of 20 46 “Study on the Situation in the Public Communal Enterprises (PCE)” , 2004 . The study analyzes the data from 2003 and the source is the final accounts. Page 66 43 enterprises for which quick comparative analysis could be made were found to have total short and long term debt in 2003 greater than their collected revenues in 2004. A smaller number had total debt higher than their billed revenues. Further in-depth and case-by- case analysis would be needed to determine the extent of the debt of municipal enterprises. 1.108 Tax burden . Communal service enterprises complain about the policy of collecting VAT on billed invoices, half of which are not collected. Tax payment on billed revenues is standard practice. However, communal enterprises in FYR Macedonia cannot easily write off old arrears, and reportedly have to pay 15 percent profit tax on the amounts proposed to be written off, except in special circumstances. This practice is supposed to provide communal enterprises with further incentive to increase their efforts to collect from their customers. This tactic does not seem to be working, however, as noncollection remains a problem nationwide and arrears continue to rise, while the financial situation of the enterprises deteriorates further. 1.109 Backlog of needs for capital repairs and investments . As indicated above, the lack of financial discipline has reduced available resources for maintenance and investments to replace or repair equipment and systems. A 2003 survey found that the average age of communal and waste disposal vehicles is about 18 years, compared to a 10-15 year life for fleet in other countries. Old equipment has higher costs for maintenance and would need to be replaced in the near future. As an indication of the magnitude of needs for investments, the Ministry of Transport and Communications reports that it receives requests from municipalities for funds in the amount of 2.5 MKD billion from its capital transfers program for communal services and can satisfy only 5-10 percent of these proposals, which are usually for routine capital repairs and minor system expansions. FYR Macedonia is in need of major new investments in wastewater treatment plants and for proper and environmentally friendly waste disposal sites (as only two sanitary landfills exist, in Skopje and Bitola). These are large investments that have normally been a priority for European Union cooperation and for which FYR Macedonia may receive substantial grants, provided it can raise counterpart local finance. To prepare the enterprises and municipalities to meet these challenging conditions, the MOTC should promote better financial management and investment selection by making its own investment grants more performance-based. 1.110 Lack of readiness for public-private partnership . Many observers in both central and local government have acknowledged the value of rethinking institutional arrangements for communal services, and in particular to consider participation of the private sector, to bring about needed changes. Currently the communal enterprises do not have ongoing partnerships with the private sector, except possibly for small service contracts in a few cases. Public-private partnerships were a subject of dialogue with KFW and the Bank in the recent past, but were not pursued. 47 Two of the mayors the 47 A World Bank loan for a Macedonia Water Utility Improvement Project was signed in 2001 to support reforms and investments in the Skopje water and wastewater utility, including preparation of a lease contract with a private partner. The loan was cancelled in 2003 without disbursements when the Skopje City Council decided not to proceed with the project design. Page 67 44 mission met in May 2006 indicated they would consider some private sector involvement, but noted likely resistance by their councils. 1.111 In any case, much needs to be done to demonstrate government willingness to allow operation on a commercial basis prior to expecting private participants to express interest in providing such services. To attract constructive and sustainable private sector participation, either with domestic or international operators, a number of obstacles would need to be overcome. The central and local governments would have to strengthen the sector framework and provide a favorable environment by: (a) eliminating legal obstacles to private involvement in water utility management, while creating the legal requirement for transparent competitive bidding for contracts; (b) avoiding political influence in setting tariff policy to ensure a transparent and predictable process with appropriate regulatory oversigh t; (c) addressing the “social” aspect of water services in tariff policy, through a separately funded, targeted subsidy system; (d) separating out the commercial activities (tariff revenue-based) from the purely public good functions, at least on an accounting basis—and where the size of market permits, preferably structuring the former as a distinct legal entity; and (e) providing a clear message of political commitment to potential private partners and to the public at large. 1.112 The annex to this chapter reviews very briefly some of the considerations involved in choosing options for public sector reform and private sector involvement, and cites examples of alternative approaches in several East and Central European countries. J. C ONCLUSION 1.113 The communal services enterprises provide a relatively good level of services to the population to date, at least from what can be readily determined, e.g. in business surveys. However, the above institutional and financial issues, if not addressed, could lead to: (i) increased costs of provision of communal services (especially higher production and distribution costs of water); (ii) pressure to raise tariffs starkly and a heavier burden on lawful paying customers due to non-collection; (iii) deterioration of services and ballooning requirements for capital repairs and investments due to past deferred maintenance. This situation could lead to a vicious cycle of increased costs/tariffs, worsening service quality, and further loss of payment discipline. 1.114 The relationship between economic growth and infrastructure development has been demonstrated through much research in recent years, as summarized in World Bank publications. (2004b, 2006b) Experiences of many countries have demonstrated a parallel relationship in the behavior of infrastructure reform and economic growth. In countries where infrastructure reforms lag behind and services are highly inadequate, economic growth also becomes more constrained. In economies that have recovered quickly, restoration and improvement of services becomes more feasible, both financially and politically. FYR Macedonia should take seriously the fundamental problems in the management of its communal services, which could increasingly hinder advances in business and household welfare as well as create a drain to the local public finances. The sector currently ranks behind that of recent EU accession countries, and especially of the Page 68 45 EU-15, in institutional practices (commercialization and political autonomy) and in key performance indicators. Without further reform the issues in communal services could hold back FYR Macedonia in its drive to meet EU standards of service and environmental quality. Page 69 46 Urban planning and land management K. I NTRODUCTION 1.115 Urban planning and land management impact strongly on the costs and availability of land for business and residential purposes, and on the quality of life in urban areas. Competitive real estate markets are key to local socio-economic development and to urban productivity. When done well, urban planning enables real estate markets to assess investment risk and reduces uncertainty by setting transparent rules and a level playing field, and enables the government to protect public interest without discouraging private sector investments. Effective land management by local governments is a tool to implement good urban planning by producing an efficient allocation of urban land that also favors positive externalities and public goods (e.g. green space) and limits negative externalities (such as congestion). Urban planning and land management both require that central governments provide an enabling legislative framework, and delegate requisite competencies to local governments while assuring their sufficient implementation capacity. 1.116 The lack of universal international models and EU standards in this area, coupled with the strong legacy of market-adverse central planning entrenched in the professional cadres, has made urban planning and land management one of the weakest links in the transition process in general, and in the decentralization process, in particular. These problems are not unique to FYR Macedonia but plague other transition countries as well, causing their land markets to significantly lag the more dynamic development of the capital and labor markets. In some cases the urban planning framework and regulations have been almost non-existent or ineffective (such as in Albania), while in many other countries urban planning and regulations have been excessively restrictive, dating back to the Sovie t economic model of “spot zoning” and “manual steering” of what can be done with urban land and by whom. The challenge of reforming urban planning and land management systems remains one of the most difficult remaining items on the transition agenda in the ECA region. And the urgency of this challenge has increased in line with the growing pressures for urban (re)development brought on by the broad shift from economic recovery to strong expansion and growth. 1.117 Problems with urban planning and land management in FYR Macedonia stem from a deficient legislative and regulatory framework at the national level, as well as highly differentiated implementation capacity at local level. The basic capacity dichotomy is between the 34 municipalities that used to be regional centers prior to the 2005 decentralization phase, and the 50 new/small/rural municipalities created coincidentally with this process. While the former can manage the adoption of decentralized functions related to urban planning and land management, the latter group appears more vulnerable in this respect and in need of substantial assistance and support. Page 70 47 L. U RBAN P LANNING AND U RBAN D EVELOPMENT 1.118 Approaches to urban planning. Urban planning should start from a clear and articulated vision of urban development ambitions of the country and of particular localities. Consequently, there is a need to undertake wider public debate about national, regional and local urban goals and objectives, before devising and applying implementing instruments. Unfortunately, the national debates about urban development goals and objectives in FYR Macedonia and many of its neighbors are too often reduced to restitution, privatization, cadastral registration and regularization issues, while local debates get reduced to ex post consultations of existing plans produced as “expert desk work”. These are prepared by urban planners educated and trained in the old system, dominated by architects who continue to view urban planning chiefly as physical design, and who see urban development mostly as physical construction of buildings, facilities and infrastructure. Implementation instruments are usually more debated than policy goals and objectives (harbored internally by planners), without much discussion with other stakeholders. 1.119 There are two competing tendencies at play in FYR Macedonia, as in many transition countries. The first is the “over-regulated” urban planning approach, typically producing a market-stifling regulatory framework which restricts market supply by raising investment uncertainty and transaction costs, and consequently produces higher prices and rents fueled by raising demand from the growing economy. The net result is insufficient urban (re)development, lack of broad-based housing affordability, and expensive provision of public space and amenities that the economy can hardly afford. On the other side, one can find an “under-regulated” urban planning approach where regulations are non-existent and/or ineffective, so that the public interest is subdued to the private one. This second scenario results in spontaneous chaotic development lacking proper provision of public space and amenities, but which can provide broad-based housing affordability to lower income groups by generating and tolerating informal settlement. Navigating between these two very unsatisfactory approaches is proving to be one of the most difficult challenges in the ECA transition countries. FYR Macedonia is facing a growing need to undertake broad-based public debate seeking reduction of over- regulation as perceived by many developers, and imposing more effective land-use harmony as sought by many planners. 1.120 While it is the central government’s role to provide an enabling urban planning framework and national goals and objectives, it is typically local governments that lead the process by which most of the urban development targets get discussed, adopted and implemented. Ideally these should be embodied in regulatory land-use zoning plans, which demarcate clear land use criteria, including zones for restricted development, and reserve rights of way for roads and infrastructure, but which are not overly detailed as used to be the case in the Soviet system. In the market economy such local plans and regulations should typically include: (i) a list of municipal urban plan objectives; (ii) demographic structure and projections; (iii) a map of the existing built-up area; Page 71 48 (iv) a map of population densities by sub-districts; (v) a zoning map with zone-specific regulations; (vi) definitions of land-use regulations (restricted use, minimum plot sizes, street set backs, maximum building height / floors, floor-to-area ratios, lot coverage etc.); (vii) a map of expected house prices in each zone, based on development standards set by the plan; (viii) a map with existing/planned rights of way for public investments; (ix) a map of land values, including trends and clusters of sales and building permits; and (x) a map of land ownership pattern. 1.121 This “road map” for urban planning in Macedonia contrasts with the current situation of old, incomplete or nonexistent urban plans for many urban areas, highly restrictive land-use regulation and protracted procedures, and missing components related to articulation of objectives, demographics, population densities, zoning regulations, and land and house prices. 1.122 Urban planning in FYR Macedonia today. Macedonian municipalities did have responsibility for preparing their urban plans prior to the July 2005 decentralization push, but now are in charge of implementing them as well (mostly through permit and approval instruments). The current urban planning regime in the country requires municipalities to prepare 10-year General Urban Plans (GUPs) and, at least in the major and secondary urban areas, 5-year Detailed Urban Plans (DUPs). The GUPs need to be consistent with the 20-year National Spatial Plan and other regional / special plans, if any. Although the core municipalities all have GUPs (some only updated to the mid- 1990s), the non-core municipalities have not. The existing DUPs cover an average of about 45 percent of urban municipal area, with the older urban municipalities having over 70 percent coverage. So construction permits continue to be issued on the old DUPs, or in case of their absence are based on negotiated spot zoning, which is prone to corruption and often ignores negative externalities created by such projects. 1.123 The urban planning process in Macedonia is overly bureaucratic, protracted and costly, while producing plans that are reactive and are often driven by investors and developers who contribute to financing of the detailed planning work. Municipalities do not yet have a vision of treating urban planning as a strategic development tool. Consequently, many GUPs and DUPs inadequately support the achievement of broader housing affordability and non-residential land use signaled by the market forces. Developers have to negotiate planning parameters on an individual basis, which creates uncertainty about street setbacks, floor-to-area ratios, road access, building heights, site coverage, minimum lot sizes, and so on—that is, factors having impact on costs and investment profitability and therefore, on final prices to space users. Additional uncertainty and risks are created by unclear pre-emption, eminent domain and expropriation powers. For example, the municipality of Strumica cannot close an expropriation process (for infrastructure) as it is required to compensate private owners in-kind and yet it does not have vacant land to offer, since land is owned only by the Page 72 49 State. And discretion over these parameters vested in municipal officials raises the risk of corruption. 1.124 Costs and capacity constraints. The quality of planning products (GUPs, DUPs) delivered by the licensed urban planners is difficult to verify without undertaking several case studies. Urban plans need to be prepared in such a way as to recognize opportunity costs, impact on housing affordability, and establish priority rules based on economic calculus, not just physical design which continues to be the dominant approach. Anecdotal evidence suggests that little attention is paid in practice to what is happening on the real estate and construction markets, and to how the detailed planning standards interact with urban development costs and affordability of market-produced real estate. Most of the desirable components of the urban plan (see above) are either missing or are inadequately prepared, which is partly due to the lack of formal regulatory requirements, partly due to the inappropriate experience of the licensed urban planners. The average age of most of the licensed urban planners and the continued preponderance of architects in their ranks calls for an in-depth evaluation and overhaul of the education, training and practice of this profession. Macedonian urban planners appear to be a tightly knit professional community difficult to penetrate for instilling the needed “paradigm shift”. They have recently managed to influence licensing regulation to preserve the oligopolistic nature of the market for their services, and have also created a self- regulating professional chamber. 1.125 Substantial financial and human resources are needed by local governments to produce the mandatory GUPs and the optional DUPs in response to market realities. The 34 older municipalities have sought to hire the staff from the closing State government departments, while the newer municipalities have been less able to tap these human resources. The staff in their urban planning units are typically composed of construction permitting and building inspection specialists who are trained in procedural and process management issues. Many non-core municipalities are financially vulnerable and do not have sufficient resources needed for outsourcing of highly technical planning work to firms of licensed planners. 1.126 The central government is aware of these capacity constraints and is monitoring this process through a special “decentralization working group” relying also on foreign donors for responding to capacity building needs in this area. The main foreign based diagnostics and capacity building effort has been provided by the European Agency for Redevelopment (EAR) and its flagship program TRAIN that has focused on urban planning capacity-building and delivered IT/GIS tools to the municipalities. The TRAIN program has not, however, provided a “hands on” pilot demonstration to test empirically whether the inexperienced municipalities will be able to utilize the capacity and equipment thus provided. 1.127 One way to lower the high costs of the “oligopolistically outsourced” urban planning services (see below), as advocated by the EU TRAIN project, is to have municipal urban planning units (UPUs) prepare required planning documentation and related data/information materials that the licensed planners can use for preparing GUPs and DUPs. It is yet to be tested whether the UPUs in the non-core municipalities will be Page 73 50 capable of performing this advance pre-planning work, but the TRAIN project is helping them develop a centralized urban planning data base. 1.128 The government should also consider other possible ways of reducing the costs of the “oligopolistic” urban planning services by securing the growth and maturing of this service market. Various figures are cited on the number of active licensed planners (80- 110) and the number of licensed firms (5-16), as well as on the prices they charge (500- 1000 EUR/hectare). However, given that so many GUPs and DUPs need be updated as soon as possible, there is little doubt about the insufficient present supply of these services. On the one hand, if municipalities prepare more advanced materials, the workload on the planning firms will decrease so the existing cadre of planners should be able to produce more plans. On the other hand, increase of new licensed planners should be actively encouraged and not controlled by their new chamber. Effective regulation of this profession should be looked into and additional incentives created for more interest in entering this career. Just as important is the need to increase their quality, especially in the area of market analysis and the ability to assess the development-cost and housing- affordability impacts of contemplated urban planning standards. 1.129 Regardless of efforts to increase the supply of plans and planners, the government review process for approval of the GUPs and DUPs needs to be reconsidered and streamlined, so that it cuts down on unnecessary bureaucratic requirements (thus reducing the scope of work for planners) and shortens the turnaround time—yet allows more time for public review and consensus building. The draft plans are currently required to be submitted to several ministries at various stages of their formulation and adoption, which delays the process unnecessarily. Permissions to convert agricultural to urban land uses must be obtained by the Ministry of Agriculture, which is reportedly very difficult and time-consuming, further impeding the supply and price of urban land. At the same time, the planning process does not benefit from the involvement of stakeholders early on, when ideas and debates could meaningfully guide planning objectives and suggest major alternatives. Public participation is rather treated in an ex post fashion (e.g., only written objections are allowed) – not unlike the practice in the other transition countries. 1.130 A comprehensive review of urban planning issues, practice and the needed reforms in FYR Macedonia (EAR 2004), concludes that the newest version of the urban planning law (recently adopted) still does not address fully the implementation practicalities and is not in sufficient harmony with much of the practice current in the legislation of most of the EU countries. Necessary urban planning reforms will further require an assurance of land-use zoning simplicity, articulation of urban goals and objectives, inclusion of market-enhancing components of urban plans, integration of spatial and socio-economic planning processes, and provision of effective implementation instruments based on lessons learned in transition and market economies at a similar level of development. There is need for determined institutional reforms in the urban planning profession, so that the recommended legislative/regulatory changes can be accepted, adopted and implemented at the central and local levels by the “converted/overhauled” planners. The experience of more advanced transition countries is not very encouraging in this respect and suggests that a very resolute reform with Page 74 51 strong central government leadership will need to be undertaken to assure effective and lasting implementation of these institutional reforms. M. U RBAN L AND M ANAGEMENT 1.131 Elements and sequencing of the reform agenda. There is a variety of ways to categorize local government activities that implement urban planning through land management. The overall goal for all these activities is “urban affordability and livability”, aiming to enable and stimulate private market production of affordable space (residential and business), while assuring spatial order and access to public space and amenities. The real estate market, like any market, responds to opportunities for achieving a sufficient level of profits providing incentives for more private investments. Profit margins improve with rising prices and/or falling costs, but since rising prices are generally not in the interest of urban development policies (higher prices reduce housing affordability), the way to keep profit margins sufficiently attractive is to lower the costs and stimulate competition. There are various public sector activities in Macedonia that can help reduce investment risks and costs and in this way keep profit margins sufficiently attractive, while at the same time assuring spatial harmony, reducing negative externalities from incompatible land uses, and providing necessary public space and amenities. 1.132 Land management activities to implement urban planning and development goals are divided in this report into the following activities, although this typology is not strictly formalized: a) land registration, cadastres, and titling 48 ; b) market information and monitoring; c) servicing land through infrastructure investment; d) increasing the supply of land on the market; e) construction permitting and building inspection; and f) property taxation. 1.133 Decentralization of these urban land management functions is far from complete in FYR Macedonia, and should not be attempted all at once. Some issues need early prioritization since they are of a cross-cutting nature and underpin the other land management activities. The three “absolute” priorities include, first , completion of the land registration and cadastre , so that clear property rights are ready for (re)allocation through market, privatization and restitution mechanisms. Second , market information —it is equally important and often forgotten, that decision makers (public and private) need to be informed about potential market prices, rents and costs, as well as permitted land uses, so that they can make efficient decisions regarding urban land. Third , the land that has clear property rights and market potential needs to be serviced with technical infrastructure , which requires public policy intervention and investments. Having these three land-management pre-requisites in place provides 48 These tasks are sometimes referred to as “land administration”. Page 75 52 necessary, but not sufficient, conditions for fostering and facilitating urban (re)development through private and public sector land transactions. 1.134 All the policy areas listed here need to be included in the Government ’s reform agenda, but within each category further sequencing and prioritization can be achieved through focused discussion on technical and financial possibilities, as moderated by the political economy constraints and imperatives. Of the first three priorities, substantial reform work is well advanced on the registration/cadastre, while market monitoring and technical infrastructure investment seem to be lagging and call for more intense attention by the politicians. Market monitoring requires organizational and technical measures to be agreed on and institutionalized, while land-servicing infrastructure depends on financing mechanisms supported by stronger municipalities and/or other institutions. Regarding the remaining three activities, reforms are also underway on construction permitting and building inspection , an area currently creating a bottleneck in the supply of land and therefore posing urgency of its own. Property taxation produces not only necessary revenues in support of debt financing of technical infrastructure investments, but also stimulates land owners to develop their properties to the highest and best uses in a timely fashion and in compliance with land-use zoning. Direct municipal involvement in increasing land supply is an area where little innovation or reform is currently underway. 1.135 Land Registration and Cadastre. The importance of land registration and cadastre has been emphasized time and again in technical assistance to all the transition countries. Issues usually revolve around geodetic identification, description and measurement (physical cadastre), establishment of property rights attached to physical objects (legal cadastre), and registration of tax liability (fiscal cadastre). There is little that this report can add to these topics, since the Bank is heavily involved in Macedonian cadastral reforms through an ongoing project, which has a broad scope including issues of land policy and administration. One aspect not encompassed by this project, as mentioned elsewhere, is that a transaction monitoring database is not within the scope, but is very important as information infrastructure needed by the market stakeholders (see below). It should also be noted that there remains a problem of illegally constructed buildings and substandard/informal settlements falling outside of the real estate cadastre, because there is as yet no legal framework for regularization. 49 1.136 Market Information and Monitoring. The urban planning processes in FYR Macedonia, as in the other transition countries, needs to become more sensitive to the price-rent-cost impacts of its planning standards, so that urban plans incorporate affordability implications to households and firms. In Poland, for example, new detailed zoning plans incorporate explicit calculation of value increase or decrease brought by changes in zoning, so that local governments are aware of financial consequences of compensation for value losses (which can be requested by landowners) as well as 49 It is necessary to distinguish between substandard settlements (see Chapter 1), which are residential communities with incomplete services and possible lacking title, often located on public land, in contrast to illegal structures which may include buildings without or in violation of permit, as in the case of unlawful additions to privately owned and legal housing or private land. Page 76 53 additional revenues from taxing windfall value appreciations (payable by landowners upon sale). Provision of reliable market monitoring should be viewed as an “information infrastructure” responsibility of the public sector as long as the private sector does not find it financially viable to deliver. Decisions of all the stakeholders – public and private – will face less uncertainty and thus less risk when transparent and reliable market information is readily available to them at marginal cost. 1.137 Formal monitoring of real estate markets does not take place in FYR Macedonia to a sufficient degree, and the stakeholders mainly rely on “insider information” in valuation, development, financing, and urban planning. Only the property tax departments come close to internally gathering more systematic market data from market transactions flowing through the transfer tax units, while the urban planners continue to be less attuned to the need for and utility of such data. And the transfer tax departments keep their data to themselves and are not willing to share it even with appraisers, whose quality of work is heavily dependent on access to reliable market evidence. What is needed is a market transactions database readily accessible (possibly for a fee) by all the stakeholders. The best institutional placement of such a database is in municipalities and their transfer tax departments. Surprisingly, the cadastre and land registration State operators have not shown much interest in assuming this function, even though their colleagues in other transition countries have been quick to jump on this revenue opportunity. Specific guidelines and methodology need to be developed nationally for an open market monitoring and a way of integrating this information into a national database. 1.138 The apparent lack of interest in market monitoring by Macedonian municipalities, as in many other transition countries, stems partly from the naïve belief that the private sector will produce this public good, partly from the lingering disrespect of markets evidenced by the “old-school” urban planners, and partly by the universal attitude of most local governments that public assets are soon to be privatized through auctions, which do not require market knowledge since asking prices at auctions are set by the State government regulation. Planners, however, should know the “value structure” of urban space and thus factor this information into their zoning delimitation and calibration decisions. Other public functions can also be informed by market monitoring: (a) public asset management; (b) real estate privatization strategy; (c) infrastructure investments to enhance land values; (d) open market operations to stabilize real estate prices and rents; and (e) promotion of real estate investments by providing reliable market information, which lowers the risk threshold. This multi-functionality of market monitoring is important to point out, since the cost of this expensive activity can be shared by several departments and at different government levels. 1.139 Market information is sensitive and valuable information. The experience of other transition countries shows that various interest groups will try to restrict access to this information, which again underscores the need for the public sector to provide it as a public good. Although real estate market transactions in Macedonia are underreported and non-transparent, a well-done market analysis should be able to articulate land value structure with sufficient reliability to inform the market players and the public policy makers about relative price attractiveness of different locations within their cities. This Page 77 54 calls for development of national standards for market monitoring and analysis, as well as creation of an institutional vehicle for implementing them, rather than relying on voluntary interest by local governments 1.140 Infrastructure Investment. Effective implementation of urban plans requires that the real estate development market can gain access to land parcels served with infrastructure, such roads and connections to necessary utilities. Municipalities need not only to develop urban plans specifying the location of new/expanded infrastructure and secure access to the land that needs to be serviced; they also require sufficient funding to undertake these investments themselves and/or by the public utilities they typically own. As in many other transition countries that have not completed decentralization, Macedonian municipalities and their utility companies generally lack sufficient own resources for infrastructure improvement and expansion, a situation exacerbated by the many cases of lingering bad debts eroding their budgets (see chapters 2 and 3). The Government is considering to remove the debt moratorium on municipalities after 2007 so that they can begin borrowing for their infrastructure investments. But without securing sufficiently robust and autonomous own revenue sources and predictable transfers, local governments will have difficulty establishing creditworthiness . 1.141 As discussed below, municipal financial capacity can also be enhanced by allowing local governments to share in proceeds from divestiture (sales, leases) of State land on their territories, and eventually to own and dispose of land assets by themselves. Even more promising in the medium- to long-run are the prospective increases of revenues from property taxation, as elaborated in chapter 2. Another medium-term alternative is to improve the operational and strategic management of municipal real estate assets in order to reduce operating expenditures and increase revenues from asset income. A further area with unexplored potential for FYR Macedonia is public-private partnerships (PPP) as a means to bring in private capital investments, as discussed further in the annex to this report. 1.142 Options for increasing land supply. As in the other transition countries, economic recovery and ensuing growth in FYR Macedonia will translate eventually into growing demand for residential real estate and rising pressures on prices, which threatens to erode the gains in improved housing affordability. The availability of a significant inflow of migrant remittances apparently feeds some of the housing demand. The problem of sluggish, unresponsive land supply slows housing production and reduces affordability, creating a major challenge for policy makers. FYR Macedonia is on the verge of a similar trend and it is a good moment to address more resolutely the emerging problems with insufficient supply of adequately planned and serviced urban land ready for orderly development. (i) Easier Acccess to Private and State Land 1.143 Private land is accessed typically through in-kind land compensation agreements, wherein the developers pay for the land with agreed floor area of a completed project. Given that there is no structured construction financing available yet in the country, the Page 78 55 developers collect advances from their captive buyers to finance construction. They may also mobilize additional funding by mortgaging their other property. Since most of the domestic developers are thinly capitalized it is in their interest to acquire control of the land without “freezing” the little capital they have available . However, this kind of “land barter” creates contractual risks and a more mature and active private land market will require more formal construction financing. 1.144 State land , which dominates urban core areas in Macedonian cities, can be accessed through tendered sales and/or through long-term land leaseholds. Sales of State land can be requested by municipalities and carried out by the Government (Ministry of Transport and Communications), or municipalities may obtain State land leaseholds for their own uses and with no ground rent payments. 1.145 The issue of municipal land ownership. The decentralization process in 2005 transferred various physical assets to municipal governments, but not land. The Macedonian Constitution states that land can only be owned by the State and private entities—an argument currently used to disallow local government ownership of land, but a principle that does not seem to be interpreted consistently. Revenues from land divestiture (sales or leaseholds) accrue only to the national government. The local authorities appear unanimous in their view that they should have the legal right to own land, which is indeed common practice in most market economies. In some cases, the national government has authorized land divestiture without consultation with the municipal governments or the local population, which is contrary to the principle of decentralization of urban planning, let alone to the EU principles of subsidiarity and citizen participation. In other cases the MOTC is reportedly not responding fast enough to municipalities' requests for land divestiture, thus discouraging interested investors. At present the municipalities can be granted land for their purposes upon request to the government, including through leasehold. An uncertain and cumbersome process of land acquisition constrains the development of a land market, suppressing supply and discouraging investors, and potentially creating upward pressure on prices. The process appears complicated with the Finance Ministry performing the treasury function and the Ministry of Transport and Communications handling land auctions. It should be examined or audited whether land divestiture is working properly, or if the government procedures are excessively protracted and unreliable as often claimed by the local governments. 1.146 What is most critical is for municipalities to be able to manage the use of land in their jurisdiction for public purposes and to ensure a responsive local land market for investment and business development. The municipality could also use land and real estate assets to boost its financial position, through market-compatible rental or leasehold, or through sales. Given the inexperience of many local authorities and the added burden of debts it is not unreasonable for the central government to exert controls on municipal land use for a period of time, although the categorical ban on land ownership is hard to justify by standard arguments. A phased strategy that provides some controls on sales but encourages responsible land management would be an important further step of the decentralization agenda. However, if the State can act more efficiently as a “divestiture service provider” in terms of selling and/or leasing the land, Page 79 56 this could work out well until municipalities enhance their capacity to manage this process in a transparent and efficient way. Comparable experience in other transition countries shows that municipal land divestiture can work well. 1.147 Municipal long-term leaseholding. As an alternative or complement to municipal land ownership, the State could grant secure long-term land leaseholds to municipalities under the condition that they resolve land use through an updated DUP. The municipality could then divest the leasehold to a private investor assuring the DUP compliance, including meeting a stipulated deadline for investment completion (to prevent land speculation). Such an arrangement would make more land available to market investors without the need to freeze their (scarce) equity capital in land assets, and thus lessen the pressure on real estate prices —especially in areas of excessive market demand. Subsequent arrangements could allow for eventual conversion of leasehold to freehold, after satisfactory investment completion and if investor wants (and has money) to buy out the leasehold. This way the State may obtain an assurance that the land transferred to municipalities is not sold to “undesirable speculators” (given the requirement of investment completion), that the land gets developed in accordance with an updated DUP, and that the municipality does not sell land just to quickly repay the outstanding debt. 50 If the land is eventually sold to the successful investor, the municipality would retain the proceeds as own revenue. The political economy consideration suggests that this could be a compromise second-best solution, provided that the long-term leaseholds are structured in a “market friendly” way, which would call for a separate feasibility study to assure effective solutions. 1.148 In the transition economies, where the economic and political processes are critically inter-related, the long-term ground lease (perpetual usufruct) may therefore be a pragmatic solution for facilitating higher urban productivity, land-use based urban redevelopment, stronger urban governance and autonomous local government finance. Its usefulness usually stems from: (a) its effectiveness in influencing the use of key land parcels; (b) a stable asset-based income source for local government when property taxation is weak; (c) opportunity for land value capture by the municipality upon its investments in local infrastructure; (d) reduced capital needs by local developers who do not have to buy expensive land; (e) discouragement of land speculation in absence of effective market calibrated property taxation; and (f) a politically more acceptable way of allowing non-resident investors to dominate the market. For these reasons the use of perpetual usufruct has been considerable in various transition countries, provided it is structured in market friendly way as in Poland (Box 4.1). 1.149 Whatever is decided with respect to municipal ownership of land, municipal governments should be able to participate in the decision making process with regard to land management and disposal. They should also receive a considerable share of the proceeds of land sales or leasehold income in order to strengthen their incentives for land management, as well as to acquire funds for local economic development and infrastructure improvements. (The regulation on divestiture of land allows for 50 Leasehold rent does not produce as high capital inflow as the freehold price does. Page 80 57 establishment of a commission for auction, but does not mention any role for local governments). Page 81 58 Box 0-1 Municipal land leaseholds (perpetual unsufruct) in Poland At the onset of transition in 1990 the perpetual usufruct (long term land leasehold) was recognized as one of the basic property rights to land besides freehold ownership . Restituted local governments took over most of the State land used for residential and local government purposes, and occupiers were granted perpetual usufruct to that land. Users of State owned land were granted perpetual usufruct subject to restitution claims. During the late 1990s the Parliament introduced a law allowing physical persons to buy out their leaseholds by paying a certain formula-driven amount, on the condition that the land use complied with urban zoning regulations. Perpetual usufruct can be granted only by the State or local government entity. If the lessee wants to sell the improvements (buildings) the perpetual land usufruct rights have to be sold with it. The perpetual land usufruct right is granted through a Civil Law contract and is registered at the land title registry (legal cadastre). This right is alienable, tradable, mortgagable and can be subordinated for financing purposes, so that foreign investors active in Poland have been using it in the similar way they do in mature market economies using perpetual usufruct (long-term land leasehold) systems. Initial granting of perpetual usufruct requires (subject to exemptions) public auction procedures with a 21 day public notice. The highest price bid is used as a basis for calculating “initial payment”, which ranges between 15-25% of the price, and may be paid in installments. The land user (tenant) pays an annual ground rent (usually between 1-3%), which is a fixed percentage of the land price/value. The ground rent (percentage) annual rate depends on the type of land use stipulated in the lease. Preferrential land uses usually get a 0.3% rate, while for housing, technical infrastructure and sport/recreation the normal percentage rate is 1%, and business purposes typically carry the rate of 3%. The annual rate does not change over the term of the leasehold (40-99 years). In the first year the lessee (tenant) pays ground rent based on the winning auction price. In the subsequent years the value of the land can be changed by the landowners if warranted by the market or inflation, but during the first 5 years it remains unchanged. These adjustments can take place as frequently as every year, although practice shows that municipalities have not used this right as often – usually during the year following elections (every 4 years). The changes may be requested by the lessee or made by the landowner. In both cases an official appraisal by the state licensed appraiser is required. The lessee may appeal the new ground rent through special tribunal and then through the court. The leasehold contract specifies permitted land use in case of undeveloped land and stipulates: (a) deadline for commencement or completion of construction; (b) type of buildings and other improvements; (c) duty to keep improvements in good condition; (d) terms and conditions for reconstruction if case of demolition/damages; and (e) compensation to lessee for improvements upon leasehold expiration. Upon violation of stipulated dates the landowner may impose additional penalty ground rents equivalent to 10% of initial (contractual) land price for each calendar year of delay. Eventually, the landowner may terminate the perpetual usufruct right, but this can be granted only through a judicial procedure. These contractual provisions are revealed in title registration records, which means that these covenants are binding not only on the initial lessee, but they run with the land thus obligating every successive lessee. The practice has shown that municipalities tend to offer 99 leases for residential uses and shorter periods for non-residential uses. The leasehold may be extended for another period of the same duration. Upon termination of the leasehold, either due to expiration or through the operation of law, the landowner has to compensate the lessee (tenant) for the value of land improvements, as of the termination date, made by the lessee in compliance with pertinent laws. In case of early termination of the leasehold the landowner returns the initial payment and the amount of ground rents prepaid (if any). The prepaid ground rents are to be indexed and the total amount of money returned to the lessee cannot exceed the value of the leasehold right at the date of termination. Land users are increasingly allowed, through successive amendments to the law, to buy out freehold ownership and thus terminate the perpetual usufruct, provided they have complied with land-use zoning and investment requirements. Special provisions govern calculation of payments in this case of early termination. Page 82 59 (ii) Land Subdivision, Consolidation and Readjustment 1.150 Land sub-division, consolidation and readjustment enhance the supply of available land by creating new lots, reducing excessive fragmentation, and rationalizing the shape of existing parcels to make them affordable and attractive to the market. When land plots are sub- optimally fragmented and “irrational” there is need for an instrument to be invoked by a municipality or the State, which “forces” pertinent landowners to participate in the land consolidation / readjustment scheme. The owners stand to win, because their land will be worth more after the scheme is implemented. In Poland, for example, a municipality can declare a land-readjustment zone and act as a catalyst of this process. This can happen only in places where public land constitutes at least 50 percent of land area. Macedonia does not have sufficient laws and regulations that facilitate this process, so there is need for a review of the current regulatory framework including comparative experience in the other transition countries. 1.151 Supply of private urban land in Macedonia, as in other countries, can grow mostly through conversion of agricultural land into urban uses. This requires both planning / zoning changes allowing for expansion of urban zone, as well as land servicing with required infrastructure, but one factor which is proving very difficult in practice is gaining approval from the Ministry of Agriculture to withdraw this land from the agricultural land pool. The rural-urban conversion process is a problem in many transition countries, so there is a rich experience of how to streamline and rationalize this process, although there is little success as yet in implementing change in this area. One needs to harmonize between the legitimate efforts to control against urban sprawl and conserve natural resources, on the one hand, and to accommodate high-value urban growth on the other. There is a need for comparative study of this serious problem, since it relates also to urban development issues of compact city shape and residential densities (significant for sustainable urban transport), and efficient access to infrastructure networks. A challenge is to define a policy that balances between encouraging redevelopment of existing city sites (e.g., converting urban “brownfield” land), and new development of peripheral sites (“greenfields”). (iii) Open Market Operations 1.152 Municipalities could pursue a more pro-active land management policy designed explicitly to stabilize their local land and housing markets. When the local market is under strong price pressure the municipality should actively seek to increase the supply of land in high-demand locations. While zoning regulations and infrastructure investments can increase significantly the supply of urban land, the municipality can also exercise “open market operation” – i.e. by selling/leasing its land (or effecting the sale of State land). This requires advance strategic planning through acquisition of land from the State as well as “land banking”, so that the municipality has a big enough land inventory to influence the supply on the market and thus prices. A precondition is that the municipality monitors the market to understand when and where to intervene. Such Page 83 60 interventions are rarely seen in the transition countries and development of this capacity in Macedonian municipalities can be developed at a later stage. Apart from current constitutional/legal restrictions, municipalities simply do not have staff at present who would articulate a municipal policy goal of developing local land markets with the view of acting as “market stabilizer”. 1.153 Construction Permitting and Building Inspection. The authority for these functions of implementing urban planning regulations has recently been decentralized to municipalities, which are still organizing and staffing their departments mostly by transferring former State employees—typically to the urban centers where these experts were employed in regional offices of the MOTC. Buildings and structures without construction permits – i.e. illegal construction – seem to be persisting in many municipalities which typically lack the requisite DUPs needed to issue these permits. Larger municipalities are contemplating various initiatives to break this vicious circle, and enabling national legislation is under preparation to facilitate the process of formalizing / regularizing the illegal construction. The persistence of this phenomenon is underscored by the lack of incentives for “illegal” owners to regularize their property and thus incur property tax liabilities, as well as overdue construction-permit and title- registration fees. As long as they have access to basic utilities and occupy their properties for their own use, there is a financial disincentive to regularize. 1.154 Several mayors noted that construction illegality caused by financial inability to pay the regularizing fees or to achieve required construction standards is relatively rare, although it applies to some of the residents of substandard settlements (see Chapter 1). In most cases the problem of illegal construction or illegal additions is a deliberate unwillingness to incur these expenses by those who can afford legality. But in cases of financial hardship, affordable regularizing solutions need to be found and demolition avoided, excepting cases where illegal construction compromises public interest, typically through trespassing of public rights of way. One such case, involving resettlement of an ethnic community to a new housing development, is being undertaken with UNDP funding in Strumica and may provide a useful pilot experience worth monitoring. 1.155 The procedures for issuing construction permits, including various approvals, are overly protracted and subject to excessive discretion, which can encourage corruption. Connection fees and impact charges are used by municipalities as general budgetary revenue without relation to cost-recovery and market value of the related infrastructure required to service the land (although the principle of cost-coverage seems to be embedded in the Law on Urban Land). Municipalities in Macedonia charge up-front connection fees at the time of building permit and these are quite high, especially in the major cities. 51 This implicit “development tax” increases the cost of land development considerably and pushes some investors (especially individual owners) into illegal construction if they can provide utilities in an alternative way. Developers pass through these costs into the final prices, which negatively affects housing affordability. The possibility of charging such high connection fees lessens municipalities’ incentive to 51 For example in Skopje 100-120 EUR/m 2 floor area. Page 84 61 increase other revenue sources such as property taxes. The exemption of non-residential property from property taxation pushes municipalities into taxing the development process (construction) rather than its outcome (type of land use), and thus discourages new real estate development. This imbalance between imposition of high construction impact fees and absence of property tax on business property should be reconsidered, as it is likely to have a distorting effect on land use and availability of serviced land in the urban market. 1.156 Intensive work is being pursued by USAID to help the local governments simplify and streamline the permit and approval procedures, in part by providing administrative software and training. The reforms include establishing the “one stop shop” principle, 52 and encouraging several municipalities to pool together their resources and arrange for outsourcing services to larger municipalities. 53 This will hopefully help reduce protracted procedures and loss of time cited by developers and investors (from about 80 days to a target of under 10, in cases where all the needed documentation is in place). The process continues to be held back by the lack of DUPs in some areas and by low capacity of the local staff to interpret DUPs prepared by the outsourced planning firms. 1.157 While the process of construction permits and approvals predates the actual construction activity, activities of building inspection and occupancy permitting take place during construction and after its completion. The administrative problems related to the permitting process pertain also to building inspection and occupancy, so are not singled out here as a separate category. 1.158 Property Taxation and Land Use. Chapter 2 discussed the current constraints in property taxation and proposed a number of measures to increase effective revenue mobilization. There are also important non-fiscal objectives that property tax can serve. The property taxation formula in Macedonia is based on market calibration, which should create appropriate incentives for more efficient land use and thus help urban planners attain proper development of urban land. These non-fiscal effects of property taxation will depend on how significant this tax becomes in investors’ calculus—further depending on how effectively the market calibration is applied and the tax implemented. 1.159 Although the annual property tax is the focus of discussion in Chapter 2 (and it has the most direct impact on land use), one remark is in store for the property transfer tax . The related fiscal valuation of property sold provides a reference for all three types of property tax in Macedonia (i.e., including also the gift and inheritance tax). Anecdotal evidence suggests that municipalities are slow in performing valuation services in connection to property transfer tax (especially significant in Skopje), when based on the new government valuation guidelines rather than on the old assessment rolls. The time required for valuation is reportedly much longer (e.g., in Skopje 4 weeks) than previously done by the PRO (4-7 days). Also, municipalities tend to over-value the tax base for the transfer tax and, faced with appeal, to disregard it. Such practices slow down the land 52 For example, already under implementation in Veles Municipality. 53 Such as arranged by Vasilevo Municipality with its neighbors. Page 85 62 development processes, because transfer tax has to be paid before the notary can “validate” a real estate transaction, which is then followed up by cadastral registration. 1.160 While it is important to verify whether the declared transaction price is close to the market level, the lengthy and hardly contestable fiscal valuation by municipalities should not slow down land development. There are alternative ways of letting the process move faster, while assuring the “price validation objective”. In Poland, for example, transfer tax is levied on the declared price and the transaction can move on the same day, while the tax department retains the right to verify the market compatibility of the declared price until three years after the transaction and then reassess back in time the transfer tax due. The tax departments have developed tables of reference prices and if declared prices are less than 10 percent of the reference level, a validating valuation is triggered automatically. This saves costs considerably and expedites transactions, while leaving less work for valuers. N. C ONCLUSIONS 1.161 Facilitating private sector growth in Macedonian cities, and ensuring affordable housing, will depend to an important degree on modernizing the activities of urban planning and land management. The land and urban policy debates have focused thus far on essential issues of property rights and registration, but there is a broader policy agenda to ensure urban productivity. Urban plans need to be produced more quickly and implemented more consistently—but it is equally critical that the new plans provide guidance for market development, through clear and simple zoning, rights of way and protection of public areas. To change past practices, whereby overly restrictive plans were negotiated, ignored, or amenable to corruption, the attitudes and education of planners and policy makers needs to be transformed as well, and they need to work with a reliable source of market information. The urban market economy also requires a more active role of local governments in land management, especially to ensure an adequate supply of serviced land. One of the most important instruments for implementing the urban plans is the provision of infrastructure connections; more progress in this area will depend on reforms in the use of taxes and fees, as well as a more hospitable framework for private participation. While local governments should be entitled to own land, with appropriate oversight through conditions for sale, other options such as long term leaseholding can be an effective means for them to influence the uses of public property. Ultimately, central government and the municipalities will have to share and convey to the public a strong vision for the development of cities which ensures that land is readily available for private investment and that the cities become hospitable and healthy locations for all residents wishing to live there. Page 86 63 Annex 1: Public or/ Private Management of Municipal Utilities Issues, Options and Examples A. Introduction The Bank has sponsored numerous studies evaluating the experience of both public management and private participation in the provision of infrastructure during the last decade and a half, and has financed projects supporting both publicly and privately managed utilities. (World Bank 2004b, 2006b, World Bank et al 2006, PPIAF 2006) The overall conclusion of these and other sources of research is that the main ingredient for success is government commitment to the path selected, and the establishment and respect of a legal/regulatory framework that enables utilities to perform their duties without undue interference in their daily management functions. To achieve a sustainable high performance in the long term, utilities need to recover their costs through a comprehensive program of cost efficiency measures, gradual tariff increases and rational subsidies. There is evidence that the transition to a privately managed utility is more successful and attractive to all stakeholders if the utility has first undertaken sufficient operational and financial reform to establish its basic financial viability, thereby enhancing its attractiveness to multiple private sector bidders. A further critical element in the transition to private participation is careful preparation and education of the public (consumers), so that their expectations are informed and realistic. B. Reform of Local Public Utilities The majority of the urban population in the world remains served (well or badly) by local publicly owned enterprises for water and sanitation, and sometimes for waste disposal and public transport. The shortages of public financing coupled with the enormity of the investment needs make the financial and operational reform of such utilities, with or without private participation, a highly relevant subject for FYR Macedonia as for many other transition and developing countries. Examples of well performing public utilities are numerous especially in advanced market economies, and span a variety of institutional forms. For example, Philadelphia Water (U.S.) is a department in the local government and does not have a board, while Singapore Water is a nationally owned enterprise. Other well-performing utilities, including some in Central and Eastern Europe, are municipally owned enterprises. The common and most important factor of success is the commitment, respect and adherence by local and central governments to the rules set for the utility to operate as a commercial entity. Successful public utilities usually try to mirror private companies in their operations. Some of the success factors are noted briefly below. External autonomy . The performance of the utility is greatly affected by the degree of independence from political interference that is provided for important decision making, such as in setting tariffs, assumption of debt, procurement, pay scales, financing policy, and responsibility for appointment of top management and board members. Page 87 64 Usually, utilities do not have complete authority to set their tariffs, but they are able to put forward proposals that are consistent with their overall revenue requirements. Tariffs are set based on well defined financial principles that aim at recovery of O&M and investment costs, and are consistent with any subsidies the utility receives from the central or local government. Successful public utilities operate under sound financial management and procurement rules. Most managers do not have total control of setting salary scales, but are able to hire and retain qualified staff and use bonuses as incentives. Managerial freedoms must be accompanied by regulatory or supervisory oversight. Board members are generally appointed by the government to represent its interests as owner. Most public utilities in transition countries rely on the government for investment financing, although others raise funds in the capital market. External Accountability : In public utilities the state or municipal owners and other external stakeholders are responsible for: (a) policy making to guide management of the utility, service delivery objectives and quality standards; (b) setting of performance targets and financial objectives; (c) regulation or monitoring compliance with the legal and contractual obligations and service standards, determining tariff levels, resolving conflict; (d) conditions for expanding service or entitlement to receive service; and (e) financing. A board with multiple actors, including representatives of the public, can offset the short term political interests and maintain objectives of financial sustainability, good management and service quality improvements. Key indicators for external accountability include whether performance indicators are set, use of external auditors, and representation of external groups in advisory or oversight bodies. The use of external auditors to enhance fiduciary responsibilities is almost universal among successful utilities. Most public utilities require authorization to secure external financing. Internal Accountability for Results : Indicators include responsiveness of the chief executive to the board, whereby performance targets are well defined and provide incentives, sanctions or both; and annual evaluation, incentives and training of staff. Responsible public utilities typically also have policies to engage and respond to consumers’ complaints and to keep the public informed. C. Options for Private Sector Participation (PSP) There is a wide range of private participation options for the provision of local infrastructure services, differing by the degree of transfer of risk and responsibilities to the private partner. The suitability of these options in each case depends on the present situation in the sector, government/political commitment to private participation, and the final desired objective to be achieved through private participation. Introduction of private sector participation in service provision is expected to improve the management of the public utilities and thereby achieve better quality of service and higher operating efficiency. Certain forms of private sector participation can also provide much needed capital for infrastructure rehabilitation and extension, although the conditions in FYR Macedonia have not reached a level yet where private risk capital can be attracted on a large scale. Depending on the type of public services, deciding on the Page 88 65 most suitable PSP option in each case must take into account political, legal, institutional, financial, as well as technical characteristics of the infrastructure and services. In addition, FYROM has many small town utilities, which might not be attractive to foreign operators because of their limited size. Bundling or merging local utilities and developing a market for domestic private operators could help to overcome this obstacle. 54 The following graph gives an overview of the broad range of institutional options, ranging from full public to full private service provision. Experience in the European region and elsewhere has shown that the initial usage of service contracts, allocated in the framework of competitive tenders, can help to dissipate public mistrust of PSP and achieve limited efficiency objectives. Performance based management contracts have also proven successful in introducing private operation while avoiding the risk of conflict related to the implementation of broader lease and concession contracts. In certain cases the use of franchising or other forms of business-to-business cooperation has helped to combine the strengths of domestic operators (local knowledge) with the strengths of international operators possessing a high degree of operational know-how (World Bank 2005). The remainder of this section summarizes very briefly a few specific examples suggesting the experiences and lessons of different private participation arrangements in the region. 54 A recent Market Development Study by the World Bank, the OECD and the Bank-Netherland Water Partnership describes a strategy how to use service area groupings to overcome market demand limitation in secondary cities, rural areas and poor neighborhoods (World Bank 2005). Page 89 66 Box A1 1 Alternative forms of public and private sector provision of utilities Full or Partial Divestiture : Transfer of responsibility for utility operations, maintenance, investment and ownership to private entities through the sale of assets or shares. Build -Operate-Transfer (BOT) Contract : Private entity assumes responsibility for the construction, financing (investment), operation and maintenance of major utility facilities (dams, treatment plants, etc.) for a period of time, then transfers (sells) it to the public sector. Concession : Transfer of responsibility for utility operations, maintenance and investment to private entities through a long- term (typically 25-30 years) contract. Assets revert to government at the end of the concession period, including any created by operator. Lease : Transfer of responsibility for utility operations and maintenance to private entity through a fixed –period rental of utility assets, including the income rights. The operator is not responsible to fund capital investments in the system. Management Contract : Transfer of responsibility for utility operations and maintenance to private entities through medium-term contracts (about 3 – 5 years). Remuneration is based on a tendered fee. Service Contrac t : Transfer of responsibility for specific tasks (typically elements of technical or administrative functions like fleet repair, IT services) to specialized private entities through short- term contracts—typically less than 2 years. (S ervice contracts are often not covered in PSP literature since they aim at measures for cost cutting or outsourcing specialized services rather than broader reform of utility operations.) Full Public Service : The utility holds full responsibility for operations, maintenance, investment and ownership of public service, with all rights and privileges. Full Public Service Dhfdhdfi Full Private Service Dives tit ure BOT Concession L ease Management Contract Service Contract Page 90 67 D. Regional Examples of Private Sector Participation in Communal Services Management Contracts : These are short term arrangements (3-5 years) where a private operator is paid a fee for providing a management team to run the public utility. All risks remain with the government, which continues to bear the loss of less than cost recovery. Payment to the contractor is not linked to tariffs, implying that large improvements in operating and investment performance are less likely than other arrangements. However, management contracts can change the way the business is run and can contain incentives to improve performance. Oftentimes, a management contract provides for bonuses where the management team helps the utility to meet specified performance targets. Management contracts can serve as transitional arrangement during which the government can prepare for further private participation. Example —A Management Contract in Yerevan, Armenia : The Yerevan water and wastewater utility entered into a management contract with an Italian operator on the basis of internationally competitive bidding in 2000. The objectives were to (a) improve the efficiency, management, operation and delivery of water and wastewater services for the Yerevan service area; and (b) lay the groundwork for the sustainable involvement of the private sector in the overall management of these services in Armenia. The arrangement consisted of four-year performance based contract to manage water and wastewater services in the YWSC service area, which was also supported by an Operating and Capital Investment Fund implemented by the private operator. Technical assistance was provided for the monitoring and auditing of the Operator's performance. A legal framework and a Water Code facilitating private sector participation in the water sector was also introduced. A significant improvement in performance indicators was achieved during the management contract: hours of daily supply increased by 50 percent, reduction in electricity consumption by 30 percent, and collections increased from 20 percent to near 100 percent. The Government continued its endorsement of private sector operation through a subsequent lease contract for the Yerevan Water and Sanitation Company, and also brought in a private management contract for the separate Armenia Water and Sanitation Company (AWSC). Relevant lessons from the experience in Armenia include: a) strong and sustained political support was necessary to achieve the significant change in operations and to initiate long term private sector participation in the sector; b) the importance of flexibility during implementation, as where the initial definition of incentive targets for the management contract was not realistic and required adjustment (a frequent experience with PSP contracts, especially when first introduced in a context of poor sector information); c) a relatively long time period is required for international recruitment of private operators—at least for first-generation PSP projects. Example—Management Contracts in four municipal water and wastewater utilities in Albania: A further example for public service provision based on an ongoing management contract is that for four cities in Albania (Durres, Fier, Lezhe, and Saranda). By introducing an incentive-based multi-city management contract with Berlinwasser, the authorities aim to: (a) improve water supply and sanitation services in the four Page 91 68 participating cities with a total of about 350,000 inhabitants, (b) achieve financial viability in the water utilities, and (c) strengthen local capacity building by bringing in internationally experienced management from the private sector. The project focuses on institution building and providing access to safe water to all levels of society, including the poor. Including four utilities under one management contract was intended to make the contract large enough to attract highly qualified international utility operators. Performance is measured through indicators of safety and quality, reliability, financial viability and service to the poor. The extent of progress towards achieving the performance targets will be directly related to the amount of annual performance-based compensation payments made under the five-year management contract. The Operator is given full responsibility for operating the water supply and sewerage systems, developing and implementing the demand management program, including a public awareness campaign, and implementing improved commercial (billing and collection) and financial management system. A separate investment fund finances works, goods, and services aimed at improving the operation of the water supply and sanitation services. Lease/Affermage Contracts. Under this arrangement, the risk to the operator is higher than with a management contract. The operator is responsible for operating and maintaining the business, but not for financing investments. In a lease, the operator retains tariff revenues and makes a lease payment to the contracting authority. In an affermage, the operator and the authority share revenues. The operator pays the contracting authority an affermage fee which varies according to demand and customer tariffs, and retains the remaining revenue. The authority must raise finance and coordinate the investment program with the operator; the operator may or may not manage the investment program. Under the lease, the operator’s remuneration depends directly on the customer tariff, and the government is obliged to design an arrangement to protect the operator from tariff related policy risk. Under affermage, the risk is smaller because the operator tariff is different from the customer tariff. These arrangements require the government to ensure adequate tariffs and gives the operator incentives to improve operating performance. Example—a Lease Contract in Gdansk, Poland: A lease contract was launched in 1992 for 30 years between the local government and the operator Saur Neptun Gdansk (SNG), a joint venture between Saur International and the City of Gdansk with Saur International having overall control of the company. SNG has the exclusive right for the provision of services. Responsibilities of the operator include: (a) maintaining service and quality of water and sewage according to Polish law; (b) reducing operating costs and water losses; (c) modernizing management systems; (d) improving customer service quality; (e) achieving EU water quality standards within specified deadlines; (f) proposing investment programs jointly with the local government. Tariffs are based on full cost recovery principles, including provision for investments in capital works. The city continues to carry out investments in coverage extensions. The local government is responsible for: asset ownership, approving, proposing, financing investments, and regulation and setting of tariffs based on SNG proposals. Government subsidies include: Page 92 69 (a) tariff subsidy to low income groups, with direct compensation to SNG; and (b) funding the investments from local budgets and loans. SNG proceeds cover operating costs, with any surplus going to the city to finance investments. The commercial risk (non-payment) is spread between SNG and the city. Consumers can be disconnected for non-payment if their dues are not paid for more than two invoicing periods. Tariffs can be reset every 12 months, and must consider improved efficiencies and considerations for particular consumer groups. The contract was modified three times, altering the timing of annual tariff negotiations, sharing of information and the operator tariff formula. A sharp drop in demand due to meter installation and closure of heavy industries affected the business. The operator diversified its services, expanded geographically, and requested additional tariff increases, most of which were approved by the city. Concessions and divestitures. A concession gives a private operator responsibility not only for the operation and maintenance of assets but also for financing and managing investments, while asset ownership remains with the government from a legal perspective. Rights to all assets including those created by the operator revert to the government after typically 25-30 years. A divestiture, like a concession, gives the operator full responsibility for operations, maintenance and investments as well as legal ownership of the assets. Concessions and divestitures are challenging, but allow for greater benefits of private participation to materialize, including mobilizing investment finance. Variants of the above models are possible. Joint ownership, for example, may help secure private participation and signal the government’s commitment to the venture, while softening the public’s sensitivities to selling public utility assets. Example—A Concession in Sofia, Bulgaria. A concession contract for 25 years (no extension possible) was signed in 2000 between the Municipality of Sofia and UK/US International Water Ltd. The operator’s obligations are specified in detail and are output based, and a minimum amount of capital investment is defined in the agreement. Service quality is to be maintained in line with Bulgarian law and international/European standards. The main responsibilities of the operator include: management, operation and maintenance, including rehabilitation and extension of existing infrastructure within the service area; and investment including specific targets over the life of the contract. The government continues to own the assets. The government allocated to the operator (Sofia Voda/SV) those risks over which SV had considerable control, while bearing most other risks, except that of demand. According to the agreement, SV bears the following risks: interest rate, revenue, demand, certain changes in law, and certain force majeure events (e.g. increased costs due to war, civil disorder and the like). Customers bear the risks of inflation, foreign exchange and tariff adjustments and other events (e.g. change in the laws). Both the government and the operator bear foreign debt exposure. The concession transaction took more than two years to be established, from the start of the preparatory studies through to final signing of the agreement. Page 93 70 Example —A Partial Divestiture in Bielsko-Biala, Poland. The water utility for the city of Bielsko-Biala, AQUA S.A./AQUA, first undertook an internal reform program to overhaul its operational and financial situation and to lay to the foundation for private participation. The overall objective of the program was to strengthen management and operation of AQUA, upgrade water supply and wastewater collection services, and expand wastewater treatment to contribute to the clean up of the region's water resources. The program achieved considerable success, as the utility now operates a water supply and wastewater system of higher complexity with fewer staff, and it has successfully introduced new accounting and management systems and procedures. Its customer service has been computerized for applications, service agreements and complaints. The company today caters to about 37,350 consumers and enjoys considerable autonomy in operation. Following a step of partial privatization, AQUA SA is currently a Public Limited Company (PLC). The owners are the city of Beilsko Biala (51.6 percent), and the International Water UU Holdings BV, a strategic private partner (33.18 percent). The remaining shares are owned by other communities served by the utility. The utility’s daily management is undertaken by a board consisting of two persons, one appointed by the city and the other appointed by the private partner. A supervisory board (City and private partner), evaluates financial and management reports and proposals by the management board and submits annual reports to shareholders, but does not interfere in management of the company. Page 94 71 Statistical Appendix Appendix Figure A1.1 Rural- Urban Poverty Convergence…only in FYR Macedonia Source: ECSPE, Weste rn Balkans Programmatic Poverty Assessment, “Poverty Profile: Changing Nature of Poverty?”, Powerpoint, June 1, 2006 0 5 1 0 1 5 2 0 25 30 35 Ur ban Rur al Urban Rur al Ur ban Rural Ur ban Rur al Albania BiH FYR Macedonia Ser bia Count r y: ur ban/ r ur al 2001 2002 2003 2004 2005 Page 95 72 Table A1.1 The poor have limited access to the labor market: Labor market indicators by location and poor/non-poor, 2002-2004. Employment rates Activity rates Unemployment rates 2002 2004 2002 2004 2002 2004 MACEDONIA 42.2 43.8 62.9 63.7 32.9 31.2 POOR 28.2 33.0 57.9 60.4 51.3 45.3 Skopje 22.0 22.3 57.4 57.1 61.6 61.0 Other Urban 29.9 35.8 69.5 66.5 57.0 46.2 Rural 29.7 35.4 51.3 56.7 42.1 37.6 NON POOR 45.7 46.4 64.1 64.5 28.7 28.0 Skopje 44.9 46.1 64.7 65.1 30.7 29.2 Other Urban 45.5 45.4 66.3 68.2 31.3 33.5 Rural 46.4 47.6 61.6 60.5 24.7 21.3 Source: WB staff calculations based on HBS 2002 and 2004. Note: HBS labor market data are not completely consistent with LFS data (Table 3), because of different sampling methods and definitions. Table A1.2 Vulnerability to poverty in 2004 (in %) 1x 1.5 x 2 x TOTAL 20.5 39.6 55.9 SECTORS Urban 19.5 37.5 53.6 Rural 21.8 42.5 59.1 REGIONS Skopje 17.9 36.6 49.3 Other 21.2 40.4 57.7 Share of population living below the poverty line multiple of Source: ECSPE, Western Balkans Poverty Assessment, “FYR Macedonia: Growth and Poverty, 2002- 2004”, June 1, 2006 Page 96 73 Table A1.3 Formal non-agricultural labor income has helped the rural poor: Sources of income as % of total, 2002 – 2004 Macedonia Skopje Other urban Rural 2002 2004 2002 2004 2002 2004 2002 2004 Agricultural income 6.2 6.5 0.0 0.0 2.3 3.2 16.0 15.9 Nonagricultural income 51.4 53.4 60.4 60.8 56.4 57.3 38.1 42.5 Formal 46.5 48.5 56.9 56.6 51.4 53.3 32.1 36.2 Informal 4.9 4.8 3.5 4.2 4.9 4.0 6.0 6.3 Public social security 29.3 27.1 33.1 31.7 30.9 28.5 24.1 21.7 Pensions 26.2 24.4 29.3 29.2 28.5 26.0 20.8 18.4 Public transfers 3.1 2.8 3.9 2.6 2.4 2.5 3.4 3.2 Private transfers 4.4 4.2 0.6 1.6 2.5 1.7 9.6 9.3 Other 8.7 8.8 5.8 5.8 7.9 9.3 12.1 10.6 TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: WB staff calculations based on HBS 2002 and 2004. 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