69990 SLOVAKIA PUBLIC EXPENDITURE REVIEW MISSION WORLD BANK, JANUARY 21-30, 2008 BACKGROUND PAPERS FISCAL SITUATION AND PUBLIC EXPENDITURE MANAGEMENT ................... 2 PUBLIC SECTOR EMPLOYMENT AND WAGES .............................................. 16 EDUCATION ................................................................................................... 22 HEALTHCARE................................................................................................ 38 PENSIONS ...................................................................................................... 50 AGRICULTURE AND RURAL DEVELOPMENT ................................................ 58 TRANSPORT................................................................................................... 73 Fiscal Situation and Public Expenditure Management 1. The budget projections for 2008 - 2010 in Slovakia’s latest Convergence Program envision the deficit continuing to decline to 0.8% of GDP in the context of economic growth close to the potential. Both spending and revenue shares are projected to fall and the debt to GDP ratio to remain below 30% of GDP. In the next decade, it will be necessary to exercise continued budget prudence so as to deal with spending pressures related to infrastructure development, social services (health and education), and to prepare for the budgetary implications of population ageing. In the environment of less buoyant growth and fiscal revenues, the need to establish clear spending priorities and to ensure value for money becomes more important than ever. Trends in public expenditure and factors behind them 2. Given the current level and the structure of public expenditures in Slovakia, some increases in spending on education, heath and infrastructure are inevitable. Thus, reallocating spending towards higher-priority areas or attracting more pronounced private sector participation will be important. 3. Expenditure as percent of GDP in Slovakia is significantly lower than the average of EU15 and NMS8. Total spending in 2006 amounted to 37% of GDP compared to an average of 47% and 41% in the EU15 and NMS8, respectively. The main reasons behind the lower spending in Slovakia are lower employees’ compensation and less rigid social benefits (as compared to “old EUâ€?). In addition, spending for health and education also appears to be somewhat lower than in EU15 (and NMS8 in case of education).1 (Figure 2). Expenditures are also lower than in Ireland, which has the smallest overall size of public sector. Unfortunately, in case of Slovakia it is not offset by higher private spending. The private spending on education is broadly in line with OECD average and somewhat below the average in case of health spending. Slovakia not only spends on education and health less than EU15 and NMS8 but also allocates a relatively lower share of spending towards “efficiency-orientedâ€? 2 programs as compared to NMS8 average and other „lower spending countriesâ€? (e.g. Ireland, UK). At the same time it spends more on “basic functionsâ€? of the state. 4. The employees’ compensation in % of GDP is relatively low in health and education. However, when wages in education are measured as a share of total spending Slovakia allocates a slightly higher share as compared to NMS and EU15 countries. Figure 1 illustrates that in 2005, employees’ compensation represented 65% of total education spending in Slovakia compared to 63% in the NMS-8 and EU15. This is however not the case in the health sector, where a share of employee compensation in 1 Although Slovakia’s spending on education health is fairly in line when its GDP per capita is considered, this still puts Slovakia behind most other EU/OECD countries 2 The “efficiency-orientedâ€? expenditures comprise categories of economic affairs (including support programs and subsidies to mining, manufacturing, agriculture, energy and service industries), environment protection, health and education. “Basic functionsâ€? of the state and pure public goods include outlays on general public services, defense, public order and safety. These two broad categories essentially pursue “economicâ€? objectives as opposed to programs aimed at income redistribution: social protection and housing and community amenities. 2 public spending represented a mere 4% percent of health spending in Slovakia, compared to 26% in the NMS. 5. Moreover, according to the government plans for 2008-2010 both health and education sectors should see a decline of the wage bill share in overall spending, despite planned wage increases for teaching staff in primary and secondary schools. Figure 1. Comparison of major Functional Figure 2 Expenditure by Economic Spending categories, % GDP, 2005 Category in % of GDP, 2006 20 50 18 Non wage spending Wage spending SK EU8 EU15 16 40 14 12 30 10 8 20 6 10 4 2 0 0 Total spending Social benefits Subsidies Compensation Intermediate Capital Capital of employees consumption investment transfers SK EU8 EU15 SK EU8 EU15 SK EU8 EU15 payable Health Education Social protection Source: Eurostat. Source: Eurostat 6. Upward pressure on public spending, however, is likely to remain strong in Slovakia. With increased prosperity, the public demand for improved Figure 3. Comparison of major Functional provision of public services will Spending categories, 2005 and MTBF (2008- continue to rise. A key area where 10) pressure will be strong is health and 14 education. Both areas are among 12 Non wage spending Wage spending sectors in focus, as set out in 10 the government’s Manifesto. 8 Nevertheless, according to the 6 Medium Term Budget Framework 4 (MTBF) the spending on education 2 and health looks to be well contained 0 2005 2008 2009 2010 2005 2008 2009 2010 2005 2008 2009 2010 (Figure 3). Between 2005 and 2010, Health Education Social protection spending on education is expected to drop by 0.5 percentage points of GDP, Source: MOF. while spending on health to stabilize on the 2008 level. Strengthening the budgetary process and control 7. Meeting spending challenges requires significant improvements to the public expenditure management system. Despite some progress, further reforms to institutional arrangements are needed to enhance aggregate spending control and strategic 3 prioritization. The introduction of a Medium-Term Budgetary Framework3 in 2005 is a welcome step in this respect. However, the experience of the past three years has pointed to several weaknesses in MTBF’s implementation: • Government priorities are not adequately integrated into the MTBF. In fact, fiscal plans beyond the following budgetary year have not been realistically estimated and fitted within the aggregate spending projections (e.g.. level of top-ups, planned increase in social benefits for unemployed, investment incentives or wage increases for teachers, etc.) • The link between the MTBF and the annual budget procedure is not sufficient. Multi-annual targets beyond the budget year are purely indicative; they result from a technical exercise. • Setting aggregate deficit targets has not proved to be effective in controlling spending and creating fiscal space for capital investment. • Existing unlimited carryovers of unspent capital funds from a current budget year to the following have complicated control of the state budget deficit. 8. Adoption of a binding multi-annual budget “envelopeâ€? system would reinforce the role of MTBF in effective fiscal planning and public finance management. The strengthening of the binding character of the three-year budgetary framework by introducing detailed medium-term expenditure ceilings can be an option. Had a binding nominal ceiling for overall expenditure been established (on the basis of the figures in the November 2004 Convergence Program), a more ambitious deficit outcome could, ceteris paribus, have been achieved. It would have brought spending savings (and corresponding deficit reduction) of about 1.5-2% of GDP over the period 2005 -2007. Ideally, the expenditure ceilings should be adjusted for interest expenditure, cyclical items such as unemployment benefits, and public investment spending. 9. Fiscal consolidation of 0.8% of GDP between 2005 and 2007 relied on across-the- board expenditure cuts, including capital spending. Moreover, revenue windfall in 2007 was used to increase current spending rather than capital spending or reduction of deficit (Figure 4). In addition, the government has clearly lacked success in implementing its medium-term plans concerning capital expenditure. Capital spending has grown marginally since 2003, being squeezed out by short-term pressures. Moreover, as a result of lack of a clear set of principles and well-defined rules for capital spending, they deviated significantly from the initial estimates (Figure 5). Thus, given the planned increase in expenditure on health care, social spending and continued high support for agriculture, creating fiscal space for capital investment would be a challenge. This requires strong budgetary procedures and institutional frameworks, including for prioritizing, implementing, and monitoring public investment projects and programs in the medium-term framework. 3 Financial management of general government is framed by three acts: The State Budget Act for a budget year, the General Government Budgetary Rules Act, and the Territorial Self-government Budgetary Rules Act. 4 Figure 4. Composition of Expenditure Adjustment in Figure 5. Capital investment Slovakia, 2005–07 Change in percentage points of GDP) plans vs. outcomes over the medium term 6.0 Actuals Capital expenditures -0.7 CP 2004 CP 2005 5.0 CP 2006 Interest payments -0.1 CP 2007 Subsidies and transfers -0.8 4.0 Goods and other -0.8 services 3.0 Gross w ages -0.2 -1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 2.0 2003 2004 2005 2006 2007 2008 2009 2010 Source: own calculations based on MoF data Source: CPs, Eurostat, staff calculations Figure 6. Revenue plans vs. Figure 7. Expenditure plans Figure 8. Deficit plans vs. outcomes over the medium vs. outcomes over the outcomes over the medium term medium term term 45 45 0 Actuals Actuals CP 2004 CP 2004 -1 CP 2005 CP 2005 40 40 CP 2006 CP 2006 CP 2007 CP 2007 -2 -3 35 35 Actuals CP 2004 -4 CP 2005 CP 2006 CP 2007 30 30 -5 2004 2005 2006 2007 2008 2009 2010 2004 2005 2006 2007 2008 2009 2010 2004 2005 2006 2007 2008 2009 2010 Source: CPs, Eurostat, staff calculations 5 10. Setting clear long-term priorities for capital spending and integrating them into the process of a multi-year planning would ensure effective use of EU funds and would help to avoid unwarranted fiscal stimulus. The negative impact of EU funds on deficit would have amounted up to 5% of GDP, for the period 2008-2010, if the funds had been used to finance expenditure that would not have occurred otherwise. In contrast, if the funds had been used to finance existing or new expenditure4, which would have taken place anyway; the negative impact could have been halved (Table 1). Table 1. Estimated net impact of EU transfers to Slovakia) % GDP 2004-2007 2008-2010 A. Contribution to EU budget and institutions 3.5 2.8 B. EU transfers to Slovakia 5.3 8.0 1. Transfers subject to "additionality" 3.5 5.3 2. Other transfers 1.8 2.7 3. Compensations 0.3 0.0 C. Total co-financing costs 2.5 1.8 D. Net impact of the budget Assuming that all spending financed by EU transfers would have occurred anyway (B-A-C) -0.7 3.3 Assuming that only transfers subject to “additionalityâ€? bring about an increase in government spending (B.2+B.3-A-C) -3.9 -2.1 Assuming that all transfers bring about offsetting increases in spending (B.3-A-C) -5.7 -5.0 Source: own calculation based on MOF data Thus, to make the best use of EU money government should set clear long-term priorities for capital spending and to the extent possible use funds which are not subject to “additionalityâ€? to finance existing expenditure commitments. At the same time, funds subject to “additionalityâ€? should be used to finance high-priority new expenditure. Efficiency of spending EU funds is also important. The fact that some funds cannot be used to finance existing expenditure should not be the reason to undertake spending that is not of high priority or that has unclear goals. 11. The government should also increase its efforts to move from input-oriented management and budgeting towards the output- and outcome-oriented ones. It is crucial to establish a clear link between the achievement of target and allocation of funds. Formulation of program structure needs to be set in a broader strategic context. There must be a clear link between the strategic plans of line ministries and their spending programs. Only then wider sectoral policies of the government can be supported by adequate budget appropriations. Efficiency considerations5 12. Better planning and increased efficiency in infrastructure investment are necessary. Slovakia scores poorly in survey-based measures of transport infrastructure quality. According to the 2008 Global Competitiveness Report, it ranks 24th out of 25 EU countries and 9th among the NMS, mainly due to the poor quality of the air and road 4 Excluding EU transfers subject to “additionalityâ€? 5 Some caution needs to be exercised while interpreting the efficiency analysis. The major caveats of this approach are: sensitivity to sample selection and measurement error and the fact that it does not capture quality of spending and exogenous factors that are beyond the direct control of policy makers. Moreover, a fair assessment of efficiency requires that inputs are evaluated against the indicators that are actually targeted by policy makers. 6 infrastructure. Measured by ton-kilometers, Slovakia performs less transport than most of the EU25 countries, and only about 55% of the volume performed by the Czech Republic or Austria. When comparing passenger transport performance, the situation is similar. Passenger cars accounted for only 70% of the passenger-kilometers performed in Slovakia, the second lowest in the EU25. However, Slovakia lags behind the EU25 average in terms of road safety – in 2005 it recorded one of the highest number of road fatalities. Table 2. Efficiency indicators for transport SK EU 15 EU 8 CZ SI AT 2005 Road Fatalities per million passenger cars 429.5 185.3 421.1 324.9 273.3 184.8 2004 Roads, goods transported (million ton-km) 18.5 97.3 27.7 46.0 9.0 39.2 2005 Roads, goods transported (million ton-km) 22.6 98.5 30.5 43.4 11.0 37.0 2004 Railways, goods transported (million ton-km) 9.7 17.5 16.2 15.1 3.1 18.8 2005 Railways, goods transported (million ton-km) 9.5 17.5 16.2 14.9 3.2 19.0 2004 Freight transport ( tonne-kilometres) 0.1 14.0 0.5 0.0 - 1.7 2005 Freight transport ( tonne-kilometres) 0.1 14.0 0.5 0.1 - 1.8 2004 Passenger transport CARS (1000 mio pkm) 24.3 271.4 47.7 67.6 16.0 82.1 2005 Passenger transport RAIL (1000 mio pkm) 2.2 21.3 4.9 6.7 0.8 8.8 Source: EC, Eurostat, own calculations 7 13. The poor state of the transport infrastructure is a consequence of inadequate investment in the previous decades, when general government investment Table 3. Transport efficiency frontier, was treated as an easy option for single input and multiple output. constraining public expenditure, and FDH Analysis 6 Input-oriented Output-oriented inefficient use of available resources . code score Rank score Rank A brief comparison of transport DE 1.00 1 1.00 1 outcomes with inputs suggests that DK 1.00 1 0.94 4 NL 1.00 1 1.00 1 Slovakia is not making the best use of SE 1.00 1 1.00 1 its resources. There is a substantial UK 1.00 1 1.00 1 scope for improving transport quality BE FI 0.90 0.33 2 3 0.88 0.96 7 2 without increasing spending. Slovakia LV 0.31 4 0.46 18 attains 65% of the transport output7 SK 0.29 5 0.65 14 FR 0.27 6 0.93 5 obtained by the most efficient EU LT 0.27 7 0.53 17 countries (e.g. Germany, the PL 0.25 8 0.63 15 SI 0.25 9 0.81 9 Netherlands, UK) with the same input, PT 0.24 10 0.79 10 ranking. 14th out of 21 countries in this ES 0.23 11 0.88 6 EL 0.23 12 0.71 13 sample. HU 0.22 13 0.62 16 The scope for potential savings is even EE CZ 0.21 0.20 14 15 0.74 0.75 12 11 larger. Slovakia could have achieved its IE 0.19 16 0.85 8 current infrastructure performance level LU 0.15 17 0.95 3 with much less public expenditure. Source: staff calculations Low input-oriented efficiency in transport is a typical feature of NMS. 14. Slovakia utilizes relatively many real health resources. It devotes approximately 7 percent of GDP to health services, three-quarters of which is via public expenditure. The public spending devoted to health are relatively low compared to the EU15 but is in line with other NMS. Although Slovakia has more hospitals, beds and PHC units, as well as significantly more outpatient visits and average length of stay in hospitals, the Slovak health sector produces a lower life expectancy, and higher death rates for circulatory, and ischemic heart diseases, as well as a higher infant mortality rate than the European average. 6 In assessing the efficiency of public sectors, we look at total public investment spending as proxies for infrastructure investment. We scored the efficiency using as input both the original expenditure variable and the orthogonalized variable (The orthogonalized expenditure variable is the residual of the linear regression between pubic expenditure and GDP per capita) The ratio of performance indicators in transport and public spending yields indicators of efficiency for each country. Finally, we use a non-parametric framework to compute a so-called production possibility frontier, and calculate input efficiency and output efficiency scores in order to rank the sample countries in terms of public spending efficiency. 7 Three sets of output were selected: 1) the number of passenger-kilometers, rail and cars 2) goods transported (million ton-km), roads and railways, and 3) road fatalities per million passenger cars. 8 Table 4. Selected health resource indicators for health sector SK EU 15 EU 8 CZ SI AT 2004 Physicians per 100000 313 335 309 348 231 345 2005 Physicians per 100000 ... 332 301 355 236 354 2006 Physicians per 100000 ... ... 341 362 ... 363 2004 Hospital beds per 100000 701 570 693 847 480 773 2005 Hospital beds per 100000 689 564 681 838 483 768 2006 Hospital beds per 100000 681 ... 702 838 476 765 2004 Absenteeism from work due to illness, days per 38.5 ... employee per year 17.3 21.4 13.4 12.1 2005 Absenteeism from work due to illness, days per 36.9 ... employee per year 17.3 22.4 12.5 11.5 2006 Absenteeism from work due to illness, days per 38.7 ... employee per year 17.1 21.2 11.5 11.3 2004 Infant deaths per 1000 live births 6.8 4.3 6.4 3.75 3.71 4.47 2005 Infant deaths per 1000 live births 7.2 4.3 5.9 3.39 4.15 4.18 2006 Infant deaths per 1000 live births ... ... 5.5 ... 3.38 3.61 2004 Life expectancy at birth, in years 74.4 79.7 73.9 76.0 77.3 79.5 2005 Life expectancy at birth, in years 74.3 79.7 73.9 76.2 77.6 79.7 2006 Life expectancy at birth, in years ... ... 74.7 ... 78.4 80.2 2005 Under-5 mortality rate 8.0 4.9 7.3 4.0 4.0 5.0 2004 Nurses (PP) per 100000 664 782 686 853 744 606 2005 Nurses (PP) per 100000 632 795 691 852 752 613 2006 Nurses (PP) per 100000 ... ... 739 860 ... 628 Source: WHO Europe Database, Eurostat, own calculations 15. Slovakia’s health sector needs to be modernized to become more technically efficient. The highest inefficiencies in the Slovak health system occur in the process of transforming intermediate health resources (hospital beds, doctors’ consultations, inpatient admissions, health workforce density, bed occupancy rate), into health outcomes. This reflects a general feature of NMS, which achieve relatively low health outcomes with high real resource use. Slovakia ranks around the average for NMS and OECD countries for overall output-oriented health efficiency, but substantially lower if taking into account only public health spending. For instance, it ranks among the worst in the sample of 22 OECD countries and non-OECD NMS, in a multiple outcome model that uses only public spending on health. (see: Table 5 Mattina and Gunnarsson, 2007). 9 Table 5 Multiple Outcome Health Sector Efficiency Model Maternal Health mortality Child Healthy life SDR: all spending (per mortality expectancy causes (percent Efficiency Rank 100,000) (per 1,000) (years) (per 100,000) of GDP) Score Latvia 61 13 60.9 1113.6 3.2 1 1 Netherlands 16 6 70.3 666.2 4 1 1 Poland 10 8 64.8 891.5 4.3 1 1 Luxembourg 28 4 70.8 706.4 4.7 1 1 Spain 5 5 71.4 600.1 5.2 1 1 Finland 5 4 70.4 660.1 6 1 1 Ireland 4 6 69.3 721.3 6 1 1 Italy 5 5 71.6 576.3 6.1 1 1 Sweden 8 4 72.3 598.5 6.5 1 1 Lithuania 19 9 61.8 1008.3 4.3 0.92 10 Hungary 11 9 62.8 1048 4.7 0.91 11 Estonia 38 8 62.7 1090.6 4.2 0.9 12 Germany 9 5 70.7 665.2 6.2 0.81 13 Denmark 7 5 69.9 749.1 6.4 0.8 14 Czech Republic 9 5 67.1 899.6 6.3 0.8 15 Austria 5 6 71 652.3 7.2 0.73 16 Portugal 8 6 67.6 727.1 6.6 0.72 17 Slovenia 17 5 68.2 759.5 6.4 0.72 18 France 17 5 71.5 605.5 7.7 0.68 19 United Kingdom 11 6 69.8 675.7 6.6 0.68 20 Norway 10 4 71.1 608.2 9.7 0.66 21 Slovak Republic 10 8 64.8 971.5 6.8 0.63 22 Source: Todd Mattina and Victoria Gunnarsson, 2007, IMF Figure 9. Efficiency of Public Spending in Reducing Child Mortality Source: Todd Mattina and Victoria Gunnarsson, 2007, IMF 16. While some education outcomes are favorable (e.g. high proportion of students who complete secondary school), others still need to be improved. Education achievement is below the OECD average according to the 2006 OECD PISA study and is strongly influenced by social background. Tertiary attainment is low, albeit rising 10 quickly; labor-market outcomes for graduates of secondary vocational programs not leading to tertiary education are poor (low employment and activity rates, high unemployment rate). 17. Education expenditure per (full-time equivalent) student in relation to GDP per capita is still low compared to the OECD average. The expenditure varied from 74% of the OECD average for secondary education in 2005 to 111.5% for tertiary education; for primary education this proportion is 70%. However, the primary and secondary pupil-teacher ratio is higher than the average of NMS and OECD countries. 18. Purely from the efficiency perspective, Table 6. Selected efficiency indicators for education education spending in sector Slovakia is in general quite strong, in line with SK EU 8 EU 15 the OECD average and 2006 PISA Scores Reading 466 485 492 similar to the other NMS. Mathematics 492 497 498 Slovakia performs Science 488 504 503 relatively worse on tertiary Student to teacher ratio (2005) Primary education 18.9 14.7 15.0 education efficiency and Secondary education 14.2 12.9 12.0 relatively better in Tertiary education 11.7 17.1 16.4 secondary education. There Educational attainment (2006) remains, however, some Secondary education 85.7 78.8 66.1 Tertiary education 13.7 19.0 25.7 scope for increased Graduation rates (2005) efficiency, which should Secondary education 83.5 85.3 86.8 be realized so that Tertiary education 30.1 30.8 35.1 additional resources in the Employment rates by education (2006) sector can be more Primary and lower secondary education 28.9 45.4 58.2 Upper secondary and post-secondary 71.9 73.1 75.6 effectively used. Tertiary education 84.8 85.9 84.9 Moreover, according to OECD8 estimates there is Source: OECD Education at a Glance 2007, Eurostat, staff calculations still some room to improving education outcome in primary and secondary education without increasing spending, or reducing pupil-teacher ratio., Holding resources constant, PISA scores could be boosted by about 4% (see Figure 10, Figure 11) Key messages / Policy Recommendations: 1) Public Expenditure Management reforms need to be intensified. Further improvements to aggregate spending control and strategic prioritization via implementing binding MTBF are desirable. 2) The government should also accelerate its efforts to move from input- oriented management and budgeting towards output- and outcome- oriented ones. It is crucial to establish a clear link between the achievement of target and allocation of funds. 8 OECD, Performance Indicators for Public Spending in Primary and Secondary Education, Economics Department Working Paper No. 546 11 3) Large inefficiencies in transport sector pose a significant fiscal challenge in terms of capital expenditure planning and prioritization as well as EU funds utilization. The government needs to ensure that increased spending will go hand in hand with improvements in the quality of infrastructure. 12 Annex 1 Figure 10. Uncertainty surrounding technical efficiency estimates at the national level Source: OECD, Performance Indicators for Public Spending in Primary and Secondary Education, Economics Department Working Paper No. 546 13 Figure 11. Uncertainty surrounding cost efficiency estimates1 Source: OECD, Performance Indicators for Public Spending in Primary and Secondary Education, Economics Department Working Paper No. 546 14 Figure 12. Functional and economic classifications of GG spending Share of GDP (%) Share of total spending (%) SK EU8 EU15 SK EU8 EU15 2005 Fuctional Classification of Expenditures Total 37.1 40.2 47.2 100.0 100.0 100.0 General public services 6.4 5.8 6.6 17.4 14.0 13.9 Defence 1.6 1.4 1.6 4.4 3.6 3.4 Public order and safety 2.1 2.0 1.8 5.6 5.1 3.8 Economic affairs 3.8 4.6 3.7 10.2 11.3 7.8 Environment protection 0.7 0.7 0.7 1.8 1.9 1.5 Housing and community amenities 0.8 0.8 1.0 2.1 1.9 2.2 Health 5.1 5.0 6.6 13.7 12.3 13.9 Recreation, culture and religion 0.9 1.2 1.0 2.3 3.1 2.2 Education 4.0 5.6 5.2 10.8 14.1 11.1 Social protection 11.7 13.3 19.0 31.7 32.7 40.2 2006 Economic Classification of Expenditures Total expenditure 37.2 40.8 46.2 100.0 100 100 Intermediate consumption 5.7 6.3 6.1 15.1 16.6 12.9 Compensation of employees 7.4 9.8 11.4 21.4 25.5 24.7 Interest 1.5 1.5 2.5 5.8 4.1 5.7 Subsidies 1.3 1.2 1.3 5.1 3.1 2.7 Social benefits 16.3 14.6 18.8 40.6 36.1 40.2 Other current expenditure 2.0 2.3 2.4 4.6 3.8 5.3 Capital transfers payable 1.1 1.2 1.2 1.4 2.3 2.7 Capital investments 1.9 3.9 2.6 6.1 8.4 5.9 of which, Gross fixed capital formation 2.2 4.0 2.6 6.3 8.6 5.9 Share of GDP (%) Share of total spending (%) SK EU8 EU15 AT CZ IE UK SK EU8 EU15 AT CZ IE UK 2005 Fuctional Classification of Expenditures Total 37.1 40.2 47.2 49.9 43.8 34.0 44.3 100.0 100.0 100.0 100.0 100.0 100.0 100.0 General public services 6.4 5.8 6.6 7.0 5.5 3.7 4.9 17.4 14.0 13.9 14.0 12.6 10.8 11.0 Defence 1.6 1.4 1.6 0.9 1.8 0.5 2.5 4.4 3.6 3.4 1.8 4.1 1.6 5.7 Public order and safety 2.1 2.0 1.8 1.4 2.2 1.5 2.6 5.6 5.1 3.8 2.9 5.1 4.5 5.8 Economic affairs 3.8 4.6 3.7 5.0 6.9 4.5 2.8 10.2 11.3 7.8 10.1 15.8 13.1 6.3 Environment protection 0.7 0.7 0.7 0.4 1.2 0.6 1.0 1.8 1.9 1.5 0.7 2.6 1.6 2.3 Housing and community amenities 0.8 0.8 1.0 0.6 1.4 1.5 0.9 2.1 1.9 2.2 1.1 3.2 4.3 2.1 Health 5.1 5.0 6.6 7.0 6.1 7.5 7.1 13.7 12.3 13.9 14.0 13.8 21.9 16.0 Recreation, culture and religion 0.9 1.2 1.0 0.9 1.2 0.5 0.9 2.3 3.1 2.2 1.9 2.7 1.5 2.0 Education 4.0 5.6 5.2 5.9 4.8 4.3 5.8 10.8 14.1 11.1 11.9 10.9 12.7 13.0 Social protection 11.7 13.3 19.0 20.8 12.8 9.5 15.9 31.7 32.7 40.2 41.6 29.1 27.9 35.8 2006 Economic Classification of Expenditures Total expenditure 37.2 40.8 46.2 49.3 43.6 34.2 43.8 100.0 100 100 100 100 100 100 Intermediate consumption 5.7 6.3 6.1 4.5 6.6 5.0 11.5 15.1 16.6 12.9 8.9 15.2 15.5 25.5 Compensation of employees 7.4 9.8 11.4 9.3 7.8 9.7 11.2 21.4 25.5 24.7 18.5 17.5 27.7 25.7 Interest 1.5 1.5 2.5 2.9 1.1 1.0 2.0 5.8 4.1 5.7 5.9 2.6 3.3 4.6 Subsidies 1.3 1.2 1.3 3.1 1.9 0.5 0.7 5.1 3.1 2.7 6.0 4.6 1.5 1.3 Social benefits 16.3 14.6 18.8 23.4 17.9 11.0 12.6 40.6 36.1 40.2 47.5 41.1 31.8 30.1 Other current expenditure 2.0 2.3 2.4 2.8 1.5 2.2 2.9 4.6 3.8 5.3 5.5 2.7 7.0 6.9 Capital transfers payable 1.1 1.2 1.2 2.7 1.8 1.1 1.1 1.4 2.3 2.7 5.7 5.7 2.6 2.1 Capital investments 1.9 3.9 2.6 0.8 5.0 3.7 1.7 6.1 8.4 5.9 2.0 10.5 10.6 3.8 of which, Gross fixed capital formation 2.2 4.0 2.6 1.1 5.0 3.7 1.8 6.3 8.6 5.9 2.2 10.7 10.6 4.0 Source: Ministry of Finance, Eurostat, Convergence Program Slovak Republic Dec. 2007, staff calculations 15 Public Sector Employment and Wages 1. Slovakia, like other small new member states of the EU, faces new challenges which are putting high demands on its public administration. A strongly performing public administration management system is also an essential ingredient of sound fiscal management and effective development planning which both require well developed strategic planning and policy management capacity and a stable and qualified human resource base. Therefore, it is crucial that the government can attract high quality labor for reasonably competitive salaries into the state and public service. 2. Compared to other EU countries, the Slovak wage budget envelope as a percentage of GDP is small. The wage bill in the last seven years was on average slightly higher than in the Czech Republic (8.3% compared to 7.7% of GDP), but lower than in the Baltic countries, Hungary, Poland, Slovenia, and the EU15 average (Figure 13). And while the Czech Republic in 2006 increased wages to 7.8% of GDP, Slovakia kept wages the lowest at 7.4% of GDP, much below Austria and Ireland (which were between 9% and 10% of GDP).9 Furthermore, the wage bill in Slovakia is more concentrated in the central government than in the local governments (Figure 15). Figure 13. GG Wage bill, 2000-06 average Figure 14. GG Wage bill, 2006, (% of (% of GDP) GDP) 13 13 12 12 11 11 10 10 9 9 8 8 7 7 6 6 IE EE EE IE EU15 EU15 HU HU PL PL SI SI CZ LT CZ LT SK SK AT AT LV LV 9 Since 2005, the majority of the health wage bill is not reported in the GG statistics. The difference in 2005 was 2.0% of GDP. However, similar practice seems to be the case in the Czech Republic and Austria. Furthermore, even if the total GG wage bill in Slovakia was increased by 2 percentage points, it would still remain among the lowest in the international comparison. 16 Figure 15. GG Wage bill split by different Figure 16. GG Total Expenditures split levels of the government, 2006, (% of by wages and other expenditure, 2006 (% GDP) of GDP) 14 55 Wage Non-w age CG SG LC SA 50 12 45 10 40 35 8 30 6 25 20 4 15 10 2 5 0 0 EE IE EU15 EE IE EU15 HU HU PL SI PL SI CZ LT CZ LT SK SK AT AT LV LV CG Central Government, SG State Government, LC Local Government, SA Social Security Funds. Source: EUROSTAT, WB staff calculations 3. The wage bill is small also as a ratio to the government total spending. Slovakia in 2006 spent about 20% of its government budget on wages, and from the comparator countries only Austria and the Czech Republic reported a lower share on wages. However, this is because both of the latter countries run much bigger public sectors. The countries with smaller governments, like the Baltic countries and Ireland, spent considerably more on the wage bill than Slovakia (from 27% to 31% of their budgets). 4. Slovakia’s spending on wages is low especially in education and health. While the wage bill as a ratio to GDP in other categories of functional classification in Slovakia is rather similar to other comparator countries (Table 7, Table 8), Slovakia spends only 0.2% of GDP on health (the Czech Republic 0.3%, Austria 0.6% and EU15 1.9% of GDP) and only 2.6% of GDP on education (Ireland 2.2%, the Czech Republic 2.8% and EU15 3.2% of GDP). The figure on health could be biased downwards because the wages in Slovak health system are paid mainly by the providers outside of the government, and, therefore, recording of the wage bill in the public accounts may not fully reflect reality10. However, the education system in Slovakia is not less public than in any other comparator country, and, therefore, the figure seems reliable. 10 The same seems true for the Czech Republic and Austria. 17 Table 7. GG spending on wages by functional classification, 2005, % of GDP EU15 CZ EE IE LV LT HU AT PL SI SK Total wage bill 10.8 7.9 9.3 9.5 10.0 10.4 12.6 9.3 10.0 11.7 7.3 General public services 1.5 1.4 1.1 1.0 1.2 1.2 2.5 1.7 1.5 1.6 1.2 Defense 0.8 0.5 0.5 0.4 0.6 0.8 0.6 0.6 0.6 0.7 0.6 Public order and safety 1.2 1.6 1.4 0.9 1.3 1.3 1.7 1.0 1.1 1.2 1.3 Economic affairs 0.5 0.4 0.6 0.8 0.4 0.4 0.8 0.7 0.4 0.6 0.5 Environment protection 0.1 0.1 0.1 0.2 0.1 0.1 0.0 0.1 0.1 0.1 0.1 Housing and community amenities 0.2 0.0 0.0 0.1 0.2 0.0 0.2 0.0 0.1 0.0 0.0 Health 1.9 0.3 1.1 3.7 1.5 1.8 1.7 0.6 1.3 2.4 0.2 Recreation, culture and religion 0.3 0.3 0.6 0.1 0.7 0.4 0.5 0.2 0.3 0.4 0.2 Education 3.2 2.8 3.4 2.2 3.6 3.8 3.7 4.0 3.9 4.2 2.6 Social protection 1.1 0.5 0.5 0.1 0.4 0.6 0.9 0.4 0.7 0.5 0.6 Source: EUROSTAT Table 8. Size of the government and share of GG wage bill on the total budget expenditures, 2005 and 2006 EU15 CZ EE IE LV LT HU AT PL SI SK 2005: Total expenditures, % of GDP 47.3 44.9 33.4 34.2 35.6 33.6 49.9 49.9 43.3 46.0 38.1 Wage bill in % of the budget 23.0 17.6 27.8 27.2 28.1 31.0 25.3 18.6 23.1 25.4 19.2 2006: Total expenditures, % of GDP 47.1 43.6 33.0 34.2 37.2 34.0 51.9 49.3 43.9 45.3 37.2 Wage bill in % of the budget 22.7 17.9 26.7 28.4 27.2 30.9 23.5 18.9 22.3 25.2 19.9 Source: EUROSTAT 5. Wages in health and education industries may not be competitive. National statistics confirm that wages in health and education – both in the public and private sectors – are significantly lower than the economy average. On average over the last seven years, wages in health and social assistance were lower than the economy average by 17% and in education by 19%. Despite the recent wage increases, in the third quarter of 2007 wages in education remained by 17% lower and in health by 13% lower that the national average (Table 9). At the same time, wages in public administration and defense remained some 20% above the national average. Table 9. Average wage in Slovakia by industries, % of economy-wide average wage 2001 2002 2003 2004 2005 2006 3Q2007 Industry 108.2 106.2 107.2 107.3 105.4 103.6 103.5 Manufacturing 104.4 102.4 103.5 103.5 101.9 100.3 100.4 Public administration, defense 118.6 122.2 121.9 121.6 121.9 127.7 123.4 Education 76.4 80.9 83.4 81.5 82.3 82.3 82.9 Health and social assistance 83.9 89.0 86.5 81.3 80.7 80.6 86.8 Source: SO SR, WB staff calculations 18 Table 10. Real wage growth in selected Slovak industries, % 2001 2002 2003 2004 2005 2006 3Q2007 Total 1.0 5.8 -2.0 2.5 6.3 3.3 4.2 Industry 2.8 3.8 -0.9 2.4 4.7 2.3 3.9 Manufacturing 2.8 3.8 -0.9 2.4 4.7 2.3 3.9 Public administration, defense -0.7 9.0 -2.3 2.2 6.5 5.6 4.6 Education -1.9 12.0 1.0 0.1 7.4 3.8 3.8 Health and social assistance 4.0 12.1 -4.7 -3.7 5.6 3.8 14.4 Source: SO SR, WB staff calculations 6. This is not only because the wage bill is small, but also because the number of employees is high. According to Labor Force Survey statistics on both public and private employment, employment in public administration, education and health as a percentage of total employment in Slovakia is higher than in many other EU countries (Figure 17 - Figure 19). Figure 17. Employment in Figure 18. Employment in Figure 19. Employment in public administration, % of education (public and health and compulsory social national employment private), % of national security (public and private), employment % of national employment 8.5 11.0 11.0 8.0 mean 2000-06 mean 2000-06 10.0 10.0 mean 2000-06 7.5 2006 2006 9.0 9.0 2006 7.0 6.5 8.0 8.0 6.0 7.0 7.0 5.5 6.0 6.0 5.0 4.5 5.0 5.0 4.0 4.0 4.0 EE IE IE EE EU15 IE EE EU15 EU15 SI PL PL PL CZ LT SI SI LT CZ CZ LT SK SK SK AT AT AT LV LV LV Source: EUROSTAT (LFS), WB staff calculations 7. The Slovak government plans to cut both public employment and the wage bill. The budget for 2008-10 assumes reduction of public employment by 7,439 employees already in 2007 (about 4.4% reduction of central government staff y/y) with full impact from the start of 2008, and corresponding reduction in the wage bill. It is open for further discussion if the reduction of staff continues also in 2008-2010 at a similar pace. Unfortunately, because of the way the budget is drafted and approved, it does not contain consolidated figures on number of government employees in 2008-2010. 19 Table 11. Number of GG employees 2004 2005 2006 2007 2008 plan Central Government 143,401 169,176 167,787 160,348 153,293 Local Governments 206,260 194,987 185,660 185,660 N/A Social and Health Insurance 8,764 9,082 9,377 9,377 N/A Total 358,425 373,245 362,824 355,385 N/A in % of national employment 16.5 16.8 15.8 15.1 N/A Actual employment figures, rather than number of positions. CG: reduction in 2008 by 7,439 employees (4.4%). Budget 2008-10 does not contain consolidated figures on GG employment in 2008-10. Source: Finance Ministry, SO SR and WB staff calculation. 8. However, the layoffs would result in the higher quality of state and public service only if public administration management system was improved.11 The layoffs should be preceded by procedural and personal audits, and by the introduction of e-government simplifications. 9. Current fiscal plans for 2009 and 2010 do not reflect overall plans for staff reduction and wage increases. The budget for 2008-2010 assumes a reduction of the public wage bill to less than 6% of GDP in 2009 and 2010, which would be less than 60% of the current EU15 or EU8 average. To prevent deterioration in the quality of public services, the government would have to very rapidly improve performance of the administration, involve significant private funds (or formalize those that are already available), and create fiscal space by efficiency savings across all chapters. It is to be expected that efficiency savings in health sector can finance wage increases there, while efficiency gains in education would need to be supported by extra funds found in other chapters to bring wages there at least to the national average wage level. Policy recommendations: • Adopt a comprehensive strategy for public sector reform and improve the public administration management system, including through procedural and personnel audits at the main spending chapters. Create human resource management systems able to enforce merit principles and to attract and retain qualified staff. Strengthen centers of excellence within the government, essential ingredients in driving successful reform processes in policy formulation and coordination. • Accelerate implementation of the e-government agenda. • Further reductions in the number of central government employees should be based on careful assessment of need rather than across-the-board cuts. Unless significant progress in designing the e-government and reforming human resource management systems is achieved, a simple reduction in public sector staff may cause deterioration of public service quality. • The wage bill should leave room for increased wage dispersion to attract and retain highly-qualified and market-demanded staff. Use efficiency savings from 11 See for example World Bank (2007), “Administrative Capacity in the New EU Member States,â€? Working Paper No. 115. 20 across the chapters to increase wages especially in these sectors where restructuring progress is evident and wages are least competitive. 21 Education Outcomes of education—what does the system achieve? 1. What Slovak students know and can do when they leave school does not equip them to be successful in the labor market nor are Slovak students competitive in international terms. 2. Slovakia has a relatively high proportion of its adult population with at least upper secondary education, at 86 percent compared with 68 percent as the OECD average (see Annex Table 1). This is encouraging since the completion of this level of education is seen as the minimum for the modern economy. However, the proportion of adults with tertiary education is low, at 14 percent compared with 26 (24) percent as the OECD (EU) average. Moreover, employment rates at 75 percent for males and 57 percent for females are below the EU averages (79 and 63 percent respectively) and, more worryingly, have been falling in recent years. Youth unemployment rates are more than twice the OECD average (Figure 20). Figure 20. Unemployment Rates for the 15-24 Year Cohort in OECD Countries, 2006 35 30 25 20 OECD Average 15 10 5 0 Denmark EU 15 Germany Czech Republic Turkey Portugal UK Mexico Japan Iceland Ireland Oceania North America Canada Europe Finland France Greece Slovakia Poland Belgium Netherlands United States Hungary Italy Korea Spain Austria New Zealand Australia Norway Switzerland Sweden Source: OECD 3. The skills and knowledge in the core skills (such as reading) in primary education are somewhat above the international average, though Slovakia ranked 21st overall out of 40 countries and regions (including the United States and five Canadian provinces) and 14th out of the 19 EU countries participating in the Program for International Reading Literacy Study. Importantly, it seems that performance over the past five years have improved significantly; Slovakia had one of the largest increases in overall attainment between 2001 and 2006. The reasons for this improvement were not the subject of this Review, but clearly should be investigated so that what has worked well is continued. 4. At age 15, however, the performance of Slovakia’s youth is less encouraging, performing below the international average in mathematics and science in the 2006 Programme for International Student Assessment (PISA). PISA tests students on the skills that they need to be effective in the labor market. Slovakia ranked 17th out the 25 EU countries participating and 30th out of 57 countries covered. Even more worrying Slovakia’s performance has deteriorated since the 2003 assessment. While Slovakia did however perform somewhat better than expected given its national income, it still lags behind its economic competitors.12 5. It is not possible to measure directly the quality of tertiary education across countries. The European University Association is conducting an evaluation of Slovak institutions which will provide important evidence for policy makers. Participation in tertiary education has been increasing in Slovakia but not as quickly as in other OECD countries. This is especially marked in the 20-30 year old age group (a group which also faces high levels of unemployment). An important part of the reason seems to be the very low enrolment levels in tertiary education which does not take place in universities but rather in technical institutions, polytechnics, colleges and the like (so-called tertiary-type B institutions). Participation in adult training overall is about at the average for OECD countries but it is much more heavily biased towards adults with higher education than other countries. 6. Of equal concern to the generally mediocre average performance of Slovak students, educational outcomes are very inequitably distributed and the Slovak school system does not help students overcome their socio-economic backgrounds. In all countries, the education and the socio-economic background of parents influence the outcomes of their children. However, in the Nordic countries for example, the school system is able, to a large extent, to overcome these differences in initial conditions. This is emphatically not so in Slovakia. In the PISA assessment, Slovakia recorded one of the highest differences in between school variance.13 As shown in Annex Table 2, the total variance in Slovakia’s 2006 PISA scores was very close to the OECD average—96.4 versus the OECD average of 100.0. But a much higher percentage of this variation—40.9 percent versus an OECD average of 33.0 percent—occurred between schools. And of that between-school variance, a larger share—11.7 percent versus the OECD average of only 7.2 percent—is explained by community and household economic differences. In other words, Slovakia’s schools are far less effective than schools in most other OECD countries in compensating for differences in household income and background. Only Bulgaria, Czech Republic, Luxembourg and Belgium had larger influences of family background. It should be noted that all these countries, plus Germany which has virtually 12 PISA is generally seen as testing the flexible and analytical skills that employers seek. However, this pattern of poor and declining performance is repeated in the TIMSS assessment at grade 8, which focuses more on the curriculum students study and is the type of test in which transition economies have generally done well. This is not so in Slovakia. 13 First Results of PISA 2003, OECD, 2006. The 2006 PISA round focused on science. Slovakia had a similar distribution of performance in the 2003 PISA which focused on mathematics. 23 the same profile as Slovakia, have large enrollments in vocational education (further discussion of this issue below). 7. The extremely poor educational chances for young Roma are well-documented (see, for example, OECD ECO/WKP (2007) 38). According to the 2001 census, only two percent of Roma had completed upper secondary school and almost none held tertiary qualifications. Moreover, it is estimated that Roma will constitute around 10 percent of the population by 2010, up from around 7 percent today. Slovakia will need to ensure that every child is able to complete a good quality education—at least to the secondary level—to meet its future demands for skills from its domestic population. The role of public expenditure in system performance 8. Among the major contributing factors to this poor system performance are the low level of spending overall, the allocation of that spending especially the very low investments in capital and teacher training, and the structure of secondary education. Figures could not be made available to the Bank team to investigate the equity of educational spending, though this is a matter that should be given urgent attention. 9. Overall public spending is low compared with OECD countries (Figure 21). Even though Slovakia’s spending is somewhat in line when its GDP per capita is considered, this still puts Slovakia behind most other EU countries. This is the situation despite relatively large increases in spending per student since 1995 and especially since 2000; these increases are a result of a combination of rising expenditures and decreases in student numbers (see Annex Figure 1). Figure 21. Public spending on education as % of GDP in EU countries, 2005 9 8 wage expenditures non-wage expenditures 7 6 5 4 3 2 1 0 Denmark Romania EU 25 EU 15 United Kingdom Germany Czech Republic Portugal Slovakia Belgium Greece Ireland Luxembourg Estonia Malta France Finland Poland Italy Netherlands Cyprus Hungary Spain Lithuania Latvia Slovenia Austria Norway Sweden Source: Eurostat 10. Slovakia spends approximately 20 percent of its overall resources devoted to primary and secondary education on non-wage items but not necessarily on the right things. Non-wage spending is relatively high in international terms and, given the potential importance of this spending to influence educational performance, this is positive. However, on closer examination, this non-wage spending is not directed in the most effective way. Two features stand out. First, spending on capital items is extremely 24 small; approximately 6 percent in 2006, and this figure has been falling over the past 3 years. Second, most of the non-wage costs are spent on things like heating and transport which do not directly improve the quality of teaching and learning.14 11. It has not been possible to identify the resources being invested in teacher training in primary and secondary education. This information is not readily collected by the national government. This is partly because of the decentralized system of education but also because most training for teachers is provided through Centers for Methodology and Counseling or through faculties for teacher education through direct transfers from the Ministry of Education. The lack of understanding of expenditures in this area is worrying because, while there is no necessary and sufficient set of conditions for improving teaching and learning, investments in upgrading teachers’ knowledge are an essential component of a successful reform strategy.15 The Government is rightly considering new laws and regulations to encourage the continued professional development of teachers. But this will need to be accompanied by increased investments in this area; the lack of understanding of current costs is of concern. Main Medium-term Opportunities and Threats to Public Spending 12. The declining number of young people offers a unique opportunity to reallocate spending within the sector, but will require improvements in both the efficiency and effectiveness of spending in order to increase educational outcomes. 13. If teacher numbers were to decline in proportion to the falling number of students, this would potentially save 13 percent of the wage bill, or around Sk3-4 bn, depending on assumptions about the rate of wage increases. Slovakia’s young population is projected to decline dramatically over the next twenty years (Table 12). Potentially, Slovakia can use this trend to make savings while at the same time increasing the proportion of students attending and completing school and improving the quality of education they receive. Slovakia’s ratio of pupils to teachers is currently a little above the international average so there is no need for pupil teacher ratios to increase (as is the case in many other South and Central European countries). These efficiency improvements should be made first to ensure that any additional budget resources allocated to the sector are used effectively. This would require a determined effort from the Ministry and other sector actors as historically teacher numbers have fallen much less quickly than the number of students. 14 In tertiary education, spending on non-wage items is 59 percent and this high compared with other countries. However, it is predominantly on transport, meals and housing rather than educational inputs. 15 See, for example, McKinsey paper 2007. 25 Table 12. Projected Change in Slovakia’s School-Age Population, 2005-2025 (in thousands) Basic Secondary Higher Year/age group 6--14 15--17 18--21 2005 594 239 346 2010 495 208 314 2015 458 167 270 2020 451 152 220 2025 440 152 203 ∆ 2005-2025 -154 -87 -143 % ∆ 2005-2025 -25.9% -36.4% -41.2% Source: UN Population Division 14. However, that opportunity risks being lost because of the rapid rise in teacher salaries. Our calculations suggest that such rises could not be afforded within the three- year planned budget even if all spending on primary and secondary education went on salaries. Raising teacher salaries to the proposed 40 percent higher than the national average wage would mean that approximately 7,500 teachers would have to leave the profession for there to be enough money in the budget—but with no money left over for other spending (or wage increases for non-teaching staff). 15. It would not be possible, at the same time, to also reduce the pupil-teacher ratio despite the sharp fall in the number of students. Eliminating this many teaching positions would mean an increase in the ratio of pupils to students as the fall in the number teachers would be faster than for students. However, the Government has said that it wishes the pupil-teacher ratio to go down. Our estimates suggest that the government will have to choose between increasing the wages of teachers as intended and improving the ratio of pupils to teachers. 16. But it should be noted, that either move would likely mean that much if not all of the projected increase in spending on primary and secondary education would go to meet increased salary costs. Little room, therefore, would be left for needed investments in non-salary items. The estimates of the impact of the rise in teacher salaries are sensitive to the underlying assumptions and the Bank team would welcome the opportunity to work with the Government to refine these figures. 17. These risks to the budget are increased because of the uncertain fiscal impact of the proposed new laws on continuous professional and career development for teachers. The Government has recognized the important role that enhancing the skills and knowledge of teachers plays in improving the quality of education provided to Slovak children. The Ministry of Education is preparing new laws which would regulate the career ladder and professional development for teachers, so as to encourage higher quality young people to enter the profession and for all teachers to have an incentive to engage in continued professional development. These goals are laudable. However, it will be very important, during the preparation of these laws, that the fiscal impact of these measures is assessed. The Bank team stands ready to help the Government conduct this assessment. 26 18. The government will therefore need to re-evaluate the importance of different policy priorities. Wages for teachers need to rise, and the target of 1.4 times the national average wage seems reasonable in international terms. Reducing the pupil-teacher ratio should not be a priority because the present figure is in line with international averages, marginal changes will not have an impact on education quality, and there are more cost- effective ways to improve outcomes. Therefore, we recommend that the number of teachers is reduced in line with pupil numbers, so that there is money to give some wage increases within the given budget. These increases should be set at such a level that the wage bill does not rise and crowd out other needed spending. In the longer term, increases in the education budget could allow further salary increases; again, with continuing efficiency improvements and ensuring that non-salary expenditures increase faster than wages. 19. The Government may be better able to achieve its objectives if it moves away from giving salary increases to all teachers. This would also be fiscally more affordable. Given the reduction in the number of students, there is not, in general, a shortage of teachers. Rather, shortages apply to particular subjects and for disadvantaged schools. The Government could consider salary increases, or incentive bonuses, for teachers in these categories. Evidence from the United States (where experience is documented most strongly) is that bonuses might need to be equivalent to 100 percent of salary to encourage the best teachers to move to disadvantaged schools. 20. Incentives can also be given to schools for improved performance. The ability of a school to improve the learning outcomes is dependent on individual teachers but also on the group of the teachers at a school working collectively. It makes sense therefore that rewards for improved performance should be assigned to schools rather than individual teachers (especially given the notoriously difficult job of evaluating the performance of individual teachers and assessing their personal contribution to collective goals). Such an incentive scheme should be targeted at schools that show the most improvement rather than those with the best overall performance. This would encourage schools in the most difficult circumstances. 21. Another source of pressure on the budget is expansion of tertiary education. It is more likely that, despite the fall in the size of the relevant age cohort, tertiary education costs will increase since Slovakia should aim to raise the enrollment ratio of students in tertiary education given the current low levels of both enrollment and, in the working population, of attainment. Extra costs in this sector might amount to some SKK 1.7 bn (Table 13) or more than 10 percent the expected tertiary education budget in 2010. A major issue, discussed briefly below, is where those resources should come from. 27 Table 13. Higher Education Enrollments and Projected Additional Resource Requirements under Alternative Expansion Scenarios, 2005-2025 No Expansion Modest Expansion Rapid Expansion (1% per year) (2% per year) 2005 Enrollments 108,608 108,608 108,608 Cohort size 346,000 346,000 346,000 Enrollment Ratio 31.4% 31.4% 31.4% Additional Resources* 0 0 0 2010 Enrollments 108,608 114,176 120,030 Cohort size 314,000 314,000 314,000 Enrollment Ratio 34.6% 36.4% 38.2% Additional Resources* 0 Sk 835 million Sk 1,713 million 2015 Enrollments 108,608 120,030 132,654 Cohort size 270,000 270,000 270,000 Enrollment Ratio 40.2% 44.5% 49.1% Additional Resources* 0 Sk 878 million Sk 1,893 million 2020 Enrollments 108,608 126,184 146,605 Cohort size 220,000 220,000 220,000 Enrollment Ratio 49.8% 57.3% 66.6% Additional Resources* 0 Sk 923 million Sk 2,093 million 2025 Enrollments 108,608 132,654 162,024 Cohort size 203,000 203,000 203,000 Enrollment Ratio 53.5% 65.3% 79.8% Additional Resources* 0 Sk 971 million Sk 2,313 million * Estimated incremental annual budget cost by comparison to preceding five-year period, recurrent plus annualized investment cost, in millions of 2005 SK. Source: Tables 6 and 7, and unit cost data from “Funding Systems and their Effects on Higher Education Systems: Country Study – Slovakia,â€? Ministry of Education, August, 2006. How might spending be reallocated within the education budget? 22. It should be possible for the resources from the education budget to be significantly reallocated, given that the number of pupils is falling sharply and yet the overall budget for education is projected to increase. Freeing up resources for non-wage expenditures will require modest increases in teacher salaries and reductions in the overall workforce roughly in line with pupil numbers. Were these efficiency savings to be captured, they could be used to improve the quality and effectiveness of education provided these resources are spent in different ways and on different things. This section sets out possible areas in which the government could give policy attention. 23. At the broadest level, opportunities should be sought to increase spending on capital investments and certain non-wage inputs which have a direct impact on the quality of education (teacher training and educational materials). However, it also matters how this money is spent. If significantly more resources were available for capital expenditure, then the Ministry of Education will need to develop a new (transparent and objective) method of allocating resources based on strategic needs rather than simply reacting to emergencies which is all they are able to do at present. It would also require 28 new agreements with municipalities and regional authorities who are formally responsible for capital investments. 24. Simplify the formula for allocating resources for primary and secondary education to provide a stronger incentive to encourage expansion of more cost-effective programs. Slovakia, like many countries, has implemented a formula to distribute resources from the central government to lower levels of government. This has the potential to increase the transparency of these transfers and improve the efficiency of the system. However, it does not appear that Slovakia has to date been able to capture these advantages. While resources are indeed being allocated through a formula, that formula is too complicated to set clear incentives to sub-national governments or to schools to improve efficiency by expanding schools which offer more cost-effective courses. The formula has the effect of reproducing historical allocations to schools. Moreover, the formula encourages regional authorities (and private schools who receive allocations on the same basis) to enroll more students in the most expensive programs as this increases their revenues the most. 25. If the formula were simplified it could more effectively encourage certain behaviors and promote more cost effective institutions. At present there are 14 different types of schools and several types of non-salary expenditure, each of which has a separate coefficient in the formula. Instead, a simplified formula might have coefficients for primary, gymnasia and vocational schools; with then an additional weighting only for rural schools. Regional authorities and municipalities would therefore have an incentive to reduce their average cost of schools, which would mean increasing the proportion of students in gymnasia. (A more radical proposal would be to have just one category of secondary schools.) This would only save resources but would likely improve the educational and labor market outcomes for students (see further below on the restructuring of secondary education). 26. Intensify programs that provide support to poor performing students, schools and municipalities and shift support away from students in higher education. Slovakia has a number of programs to support students from poorer backgrounds or from otherwise disadvantaged populations. The most significant of these—providing scholarships and loans to students and providing teaching assistants to Roma students—together added up to Sk 949 m in 2006 (though some scholarships were provided through the Ministry of Labor and Social Affairs). However, these resources are not devoted to the poorest students because the majority of scholarship money is given to students attending tertiary education (59 percent of scholarship students are attending tertiary education and consume fully 86 percent of the money allocated to scholarships). The most-needy students, in general, do not manage to complete secondary education. 27. It is important that these programs are effectively targeted on the most-needy students, since the central government, at present, has few other programs to support disadvantaged schools. Almost all the money allotted for primary and secondary education is distributed to sub-national governments through the funding formula. This leaves few resources at the national level for addressing equity. 29 28. Moreover, the fact that tuition in universities continues to be free of charge to full- time students (a manifesto pledge of the present government) provides a much larger further subsidy to students from better-off families. Extra-mural students will pay fees, but these students are more likely to come from disadvantaged backgrounds since they were not able to receive a high quality education preparing them for entry into university. Fee policies should be even-handed between different types of tertiary student, to motivate students to attend tertiary-type B institutions and learn part-time. In this way, a lifelong learning system will be encouraged. 29. Increase access to good quality pre-school and early childhood programs, especially for students from poor backgrounds. Slovakia’s enrollment rates in pre- school around the international average as a result of recent government initiatives. Further efforts in this area are warranted. As are efforts to increase the proportion of very young children in early childhood care, which is very low in Slovakia. This will require careful coordination with municipalities who have been assigned these responsibilities since 2004 and the Ministry of Labor and Social Affairs which provides social support. Clear regulation and performance standards set by the national ministries will be needed to ensure adequate coverage of good quality institutions. The externalities for early childhood education and care argue for public funds to be focused on poorer municipalities. 30. Delay early tracking in secondary education to provide students with a stronger core of key competencies needed for the future workforce. This change would likely increase both the overall performance of the system as well as improve equitable outcomes. Slovakia begins to separate children into different educational tracks at a relatively early age. This appears to be an important factor in explaining the poor results obtained in the PISA exam. The results in PISA 2003 show that, on average across OECD countries, students in pre-vocational and vocational programs score 45 points lower than students in general programmes… After adjusting for socio-economic factors, the performance difference… [remains] at 27 score points on average across OECD countries. (OECD, Education at a Glance 2007, p. 275) 31. It is important to understand that this early tracking has the effect of both lowering overall average performance and increasing the inequitable distribution of performance. Focusing just on the national Slovak context, students from certain types of vocational programs have significantly worse labor market outcomes (Figure 22). 30 Figure 22. Unemployment Rates by Educational Attainment, 2006 University - Master degree 3.2 University - Bachelor degree 4.7 Higher professional 3 Secondary specialised w ith maturita 8.1 Secondary general w ith maturita 9.5 Secondary vocational w ith maturita 12.7 Secondary education w ithout maturita 13.7 Secondary vocational w ithout maturita 15.4 Basic 48 0 10 20 30 40 50 60 Source: Central Statistical Office 32. In addition to these outcomes, it is also important to consider their relative cost. The unit cost of secondary vocational and secondary technical schools are 1.4 and 2.2 times larger than the costs for general education. 33. Promote greater diversity in institutions and courses in tertiary education, especially of shorter, more vocationally oriented programs to promote lifelong learning. Future increases in tertiary education enrollments should be in non-university institutions. However, this will require a major investment as the current supply of such institutions is very small. Ireland successfully used Structural Funds to create its supply of such institutions, so it may be that the investment costs need not be borne mainly by the government budget. These institutions not only cater for young people leaving secondary education, but also for those already in the workforce who wish to upgrade their skills and knowledge but cannot afford or do not wish to take several years away from work to complete a university course. Universities presently offered some courses of tertiary type-B, but the experience around the world from a variety of different national contexts is that it is difficult for institutions to combine successfully these two different missions (see Grubb 2003). 34. Slovakia also spends more per student on tertiary education, relative to what it spends on primary education, than any other OECD country (Annex Table 3). Likely increases in enrollments in tertiary education will make this imbalance worse unless the Government takes specific action to restrain increases in unit costs or reduces spending from public sources. As can also be seen from Annex Table 3, unit costs in non- university education are significantly less in all countries than the unit costs in universities; another reason for Slovakia to invest in different types of post-secondary education and training. 31 Annex Annex Table 1. Population that has attained at least upper secondary education (2005) Percentage, by age group Age group 25-64 25-34 35-44 45-54 55-64 Australia 65 79 66 61 50 Austria3 81 87 84 78 70 Belgium 66 81 72 60 48 Canada 85 91 88 84 75 Czech Republic 90 94 93 88 83 Denmark 81 87 83 78 75 Finland 79 89 87 78 61 France 66 81 71 60 51 Germany 83 84 85 84 79 Greece 57 74 65 51 32 Hungary 76 85 81 76 61 Iceland 63 69 67 63 49 Ireland 65 81 70 55 40 Italy 50 66 54 46 30 Korea 76 97 88 60 35 Luxembourg 66 77 68 60 55 Mexico 21 24 23 20 12 Netherlands 72 81 76 69 59 New Zealand 79 85 82 78 66 Norway 77 83 78 74 73 Poland 51 62 50 47 43 Portugal 26 43 26 19 13 Slovak Republic 86 93 92 85 68 Spain 49 64 54 41 26 Sweden 84 91 90 82 72 Switzerland 83 88 85 82 77 Turkey 27 36 25 21 15 United Kingdom3 67 73 67 65 60 United States 88 87 88 89 86 OECD average 68 77 71 64 54 EU19 average 68 79 72 64 54 Source: OECD Education at Glance, 2007 Annex Table 2. Between-school and within-school variance in student performance on the science scale in PISA 2006 Variance expressed as a percentage of the average variance in student performance (SP) across OECD countries1 Variance explained Total by students' study variance Variance explained by Variance explained by programmes and between Total variance in the PISA index of the PISA index of Variance explained the PISA index of schools SP expressed as economic, social and economic, social and by students' study Total economic, social expressed a percentage of Total Total cultural status of cultural status of programmes variance and cultural status as a the average variance variance students students and schools in SP2 of students and percentage variance in in SP in SP schools of the total student between within performance variance schools4 schools across OECD within the Between- Within- Between- Within- Between- Within- Between- Within- country5 countries3 school school school school school school school school variance variance variance variance variance variance variance variance explained explained explained explained explained explained explained explained Selected OECD Austria 9 551 106.5 60.7 50.7 7.9 0.6 40.1 0.6 45.2 0.3 49.5 0.8 57.0 Belgium 9 791 109.1 57.0 53.0 11.7 2.0 40.7 2.0 45.4 12.7 50.6 13.3 52.3 Czech Republic 9 687 108.0 62.4 55.9 12.7 1.7 43.5 1.8 50.2 0.4 52.2 2.0 57.8 Denmark 8 580 95.6 14.8 82.0 6.0 8.1 8.2 8.3 1.6 0.1 8.6 8.4 15.4 Finland 7 301 81.4 4.7 76.7 1.2 5.5 1.3 5.5 0.0 0.0 1.3 5.5 5.8 France w w w w w w w w w w w w w Germany 9 908 110.4 66.2 50.8 11.6 1.4 49.4 1.4 56.0 2.0 58.1 3.3 59.9 Greece 8 420 93.9 48.5 55.1 11.3 1.7 29.1 1.8 37.3 0.0 41.7 1.7 51.7 Hungary 7 720 86.1 60.5 38.5 9.4 0.2 47.5 0.2 46.2 0.0 51.6 0.3 70.4 Iceland 9 263 103.2 9.3 95.4 0.1 6.4 0.2 6.3 1.8 0.3 2.0 6.6 9.0 Ireland 8 871 98.9 16.9 82.6 7.4 4.9 11.4 5.0 1.1 3.6 11.4 8.3 17.0 Italy 9 045 100.8 52.6 51.8 4.8 0.4 27.6 0.5 26.4 0.1 31.9 0.5 52.1 Japan 9 812 109.4 53.0 59.4 2.9 0.1 29.0 0.1 9.7 0.0 30.2 0.1 48.5 Korea 8 093 90.2 31.8 59.3 3.8 0.4 16.9 0.4 15.2 0.4 20.9 0.8 35.3 Luxembourg 9 356 104.3 30.5 72.7 12.4 6.0 27.3 6.0 26.4 22.0 28.1 23.9 29.2 Mexico 6 490 72.3 25.5 38.2 4.2 0.3 13.3 0.4 9.1 0.0 16.8 0.4 35.3 Netherlands 9 081 101.2 59.6 40.0 6.8 0.7 41.1 0.8 55.7 8.8 56.3 9.1 58.9 New Zealand 11 230 125.2 20.0 106.0 10.6 10.1 14.9 10.2 0.2 1.9 14.9 11.7 15.9 Norway 8 894 99.1 9.9 88.8 2.8 5.2 3.7 5.2 0.8 0.1 4.0 5.2 9.9 Poland 8 047 89.7 12.2 78.9 5.5 8.6 5.8 8.7 1.0 0.5 6.0 8.9 13.6 Portugal 7 824 87.2 27.8 58.5 8.8 3.6 14.7 3.6 20.7 11.9 23.6 13.6 31.9 Slovak Republic 8 648 96.4 40.9 55.6 11.7 2.6 23.3 2.5 23.2 1.3 29.4 3.6 42.4 Spain 8 150 90.8 12.7 74.2 5.0 5.3 6.2 5.4 0.0 0.1 6.2 5.5 13.9 Sweden 8 635 96.3 11.5 85.8 4.4 6.2 6.1 6.1 4.2 0.0 6.7 5.9 12.0 Switzerland 9 830 109.6 37.5 66.7 8.0 4.8 17.0 4.8 5.9 1.0 18.0 5.6 34.2 United Kingdom 11 156 124.4 23.5 97.8 8.6 6.1 14.8 6.4 0.6 1.2 14.9 7.4 18.9 United States 11 186 124.7 29.1 94.0 12.7 7.7 18.9 7.7 5.8 4.3 20.8 10.7 23.3 OECD average 8 971 100.0 33.0 68.1 7.2 3.8 20.5 3.8 17.8 2.8 24.3 6.1 Selected Partners Bulgaria 11 352 126.5 69.6 59.4 16.4 1.0 47.5 0.9 23.6 0.2 48.2 1.2 55.0 Croatia 7 356 82.0 33.8 50.0 6.0 1.3 20.4 1.3 25.7 8.2 26.4 8.5 41.3 Estonia 6 986 77.9 16.0 61.5 3.8 2.9 6.5 2.9 0.1 0.5 6.4 3.3 20.5 Latvia 7 056 78.7 14.5 64.2 4.3 3.1 6.7 3.1 0.6 1.6 6.8 4.5 18.4 Liechtenstein 9 330 104.0 c c c c c c c c c c c Lithuania 8 082 90.1 25.5 65.4 9.0 3.8 15.0 3.9 12.2 0.5 17.5 4.3 28.3 Montenegro 6 390 71.2 20.2 50.8 3.5 0.8 12.0 0.9 15.4 5.0 16.4 5.2 28.3 Romania 6 585 73.4 35.5 37.7 6.8 1.0 19.8 1.0 19.5 0.0 25.2 1.0 48.3 Russian Federation 8 023 89.4 24.1 66.9 4.6 2.2 8.2 2.2 5.0 4.1 9.4 5.5 27.0 Serbia 7 224 80.5 34.3 48.7 6.6 1.0 22.9 1.0 22.2 3.2 25.5 3.7 42.6 Slovenia 9 628 107.3 64.8 42.8 6.2 0.3 46.2 0.3 52.0 0.1 54.3 0.4 60.4 1. The variance components were estimated for all students in participating countries with data on socio-economic background and study programmes. 2. The total variance in student performance is calculated from the square of the standard deviation for the students used in the analysis. The statistical variance in student performance and not the standard deviation is used for this comparison to allow for the decomposition. 3. The sum of the between- and within-school variance components, as an estimate from a sample, does not necessarily add up to the total. 4. In some countries, sub-units within schools were sampled instead of schools and this may affect the estimation of the between-school variance components (see Annex A2). 5. This index is often referred to as the intra-class correlation (rho). 34 Annex Figure 1. Changes in the number of students as well as changes in expenditure on educational institutions per student, by level of education (1995, 2004) Index of change between 1995 and 2004 (1995=100, 2004 constant prices ) Change in expenditure Change in the number of students (in full-time equivalents) Change in expenditure per student Index of change (1995=100) 220 210 200 190 180 170 160 150 140 130 120 110 100 90 80 Mexico Slovak Republic3 United States Netherlands Australia Greece1,3 Turkey1,2 Israel Czech Republic Switzerland1,2 Italy1, 2 Norway1 Denmark3 Brazil1,2,3 Japan3 Portugal 2 Hungary2 Ireland Poland1,2 Germany Sweden Finland Spain Chile United Kingdom Index of change (1995=100) 220 210 200 190 180 170 160 150 140 130 120 110 100 90 80 70 60 Mexico Slovak Republic3 Australia Netherlands United States Greece1 Turkey2 Israel Czech Republic Hungary2 Brazil1,2,3 Poland1,2 Portugal 2 Japan3 Norway1 Austria Denmark3 Ireland Switzerland1,2 Germany Italy Sweden Chile Finland Spain United Kingdom Source: OECD Education at Glance, 2007 Annex Table 3. Annual expenditure on educational institutions per student for all services (2004), relative to spending on primary education (in equivalent USD converted using PPPs for private consumption, by level of education, based on full-time equivalents) Pre- Tertiary education (including R&D Secondary education primary activities) All tertiary education Post- education Primary to (for Tertiary-type A excluding tertiary Lower Upper All secondary All children 3 Primary Tertiary-type & advanced R&D education secondary secondary secondary non- tertiary years and education B education research activities education education education tertiary education older) programmes education (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) OECD countries Australia m 100 134 153 141 138 146 260 243 177 139 Austria 80 100 117 130 123 m 131 186 182 125 128 Belgium 74 100 m m 117 m m m 178 119 121 Canada m m m m m m m m m m m Czech Republic 114 100 171 172 171 78 117 256 242 205 161 Denmark 66 100 102 117 110 m m m 188 141 121 Finland 77 100 160 117 133 m 156 224 224 138 140 France 97 100 154 194 172 80 179 220 210 145 155 Germany 111 100 123 211 153 214 130 267 248 156 158 Greece m m m m m m m m m m m Hungary 1 110 100 89 103 96 165 132 187 185 146 113 Iceland 72 100 98 87 92 m m m 105 m 98 Ireland 91 100 128 135 131 95 m m 188 137 124 Italy 1 81 100 104 108 106 m 113 104 105 65 105 Japan 60 100 112 120 116 m 116 210 186 m 124 Korea 56 100 135 167 151 m 95 192 157 137 133 Luxembourg 1 m 100 134 132 133 m m m m m m Mexico 106 100 95 151 113 m m m 341 285 126 Netherlands 93 100 128 113 121 106 m 223 223 139 129 New Zealand 99 100 103 143 121 104 112 189 171 159 121 Norway 51 100 111 146 130 m m m 176 122 126 Poland 1 129 100 90 94 92 101 88 143 141 124 106 Portugal 1 95 100 136 127 132 m m m 165 m 124 Slovak Republic 124 100 115 152 132 m m 315 315 286 147 Spain 93 100 m m 135 m 168 193 189 138 133 Sweden 62 67 m m 91 m 113 130 127 93 89 Switzerland 1 42 100 107 179 142 98 70 273 256 146 139 Turkey 1 m 100 m 161 161 m m m m 378 136 United Kingdom 133 100 m m 119 m m m 193 148 122 United States 90 100 108 119 113 m m m 255 225 137 OECD average 81 100 118 135 125 79 m m 190 137 120 1. Public institutions only. m = data not available or reliable Source: OECD. See Annex 3 for notes (www.oecd.org/edu/eag2007). 37 Healthcare 1. There is considerable space for improving efficiency in the health sector and incur savings to improve quality and wipe out hospital debts instead of shifting them to insurers. The Slovak health sector reports overcapacities in hospitals, hospital beds, and outpatient posts resulting in idle resources, highest outpatient visit rates, long average lengths of hospitalization, and misallocation of staff caused by salary distortion; in addition the sector is burdened with growing indebtedness in public hospitals. Slovakia reports relatively high mortality rates for life-style diseases. This suggests there is scope for reexamining provider structures, quality and treatments pattern in the provision of care and prescription of pharmaceuticals; and changing incentives through contracting and provider payment to award better quality and efficiency. 2. Debts in hospitals have been increasing reaching 0.4% of GDP, posing a fiscal risk. In 2007, about 71% of total debt stock accumulated in state-owned hospitals and 28% in regional hospitals (Table 14). The debt structure of MOH-owned hospitals includes 53% for drugs and medical technology investment; 13% social insurance and 8% towards utility companies. Regional hospital debts are 17% towards social insurance and 19% utility providers. Resolving the debts towards the public sector is a pre- condition for public hospitals to be able to access EU structural funds in 2008. The MOH budget does not plan to resolve this debt situation; rather debts are planned to be financed with revenues from insurance companies, putting upward pressure on contribution rates. Given the better performance of joint-stock hospitals, the Government should continue transforming hospital ownership into joint stock companies, and bind hospitals by tight budgetary management. Hospital managers of indebted hospitals need to be kept accountable and replaced by professional managers to bring hospitals back into balance. Table 14. Accumulated debts (incl. arrears) in health sector, 2003 - 2007 2003 2004 2005 2006 2007 MOH hospitals (11,482) (13,887) (2,814) (4,551) (5,230) Regional hospitals (2,014) (3,191) (2,422) (2,275) (2,094) Joint stock hospitals - - - (15) (21) Health insurance (12,485) (4,987) (1,217) (97) (22) Total, in million SK (25,981) (22,065) (6,453) (6,938) (7,367) In % of GDP 2.14% 1.62% 0.43% 0.42% 0.41% Source: Ministry of Health Inefficiencies in the provision of care and pharmaceuticals 3. Overcapacity in hospital care should be rationalized. Slovakia reports more hospitals and hospital beds (681 per 100,000) than European countries with more efficient health sectors including Slovenia and Estonia that are more advanced in reforms. A relatively long average length of stay (ALOS) combined with a rather low occupancy rate of 67 % points to idle resources, suggesting that patients are kept unnecessarily hospitalized (Figure 23 - Figure 26). Modernizing treatment patterns should allow reducing the average length of stay by about three days. Slovakia could generate substantial savings by aiming to reach hospital capacity and treatment levels comparable to Slovenia. To reach these levels, about half of Slovakia’s hospitals and 10,700 hospital 38 beds could be closed. For instance, if the median travel time is determined to be 90 minutes for tertiary care, 60 minutes for regional-level secondary care and 30 minutes for district-level secondary care, the minimum provider network can be reduced to 7 tertiary care providers, 9 regional secondary care providers and 39 district secondary care providers, allowing at least 20 hospitals to be closed16. Figure 23. Hospitals per 100,000 pop Figure 24. Hospital beds per 100,000 pop 4 3.5 900 3.5 800 3 2.7 700 2.5 2.2 600 1.8 1.8 500 2 1.4 1.5 1.5 400 1 300 200 0.5 100 0 0 Den Slov NL Belg Bu lg Ro m Slov Lat iv Hung Lithu Cze c Pola Est o Sl C Sl d N ni a H ia Po ary C kia ro or un ze ov ov la at ch w mark g e a en ia aki a n nd a ria a nia ium n ia a hR ay ania ary Re p Figure 25. Inpatient admission per 100 Figure 26. ALOS in hospitals pop 8.4 8.5 30 9 7.8 8.1 8 7.2 25 6.3 6.6 7 5.8 6.2 20 6 5 4 4.2 15 3.4 4 10 3 2 5 1 0 0 Den m Sw ed F inla Slo v Esto Hung L ithu Croa Cze c Slo v Irel a L at v D en m It aly Sw ed Cro at Polan Slo ve Slo va Esto n Bu lga Cze ch L atvia L ith ua Ro ma Hu gar en ia ak ia n ia nd ia ti a nd hR ania ar y en ark en ia n ia kia d ia ark ria nia y n ia R Source: WHO. http://data.euro.who.int/hfadb 4. The high number of outpatient practices supports the overuse of outpatient care. The number of outpatient visits per capita per year is very high (13) and twice as high compared to the European average. Generally, countries with a higher number of outpatient units also report higher visit rates (Figure 27, Figure 28). A reduction in the number of providers - or at least exclude half of them from insurance contracts, particularly specialists - combined with adherence to standardized treatment protocols would support reducing the current overuse of services and decrease recurrent and capital costs. 16 The World Bank: Slovak Republic: Reforming the health sector for greater fiscal sustainability. 2006. 39 Figure 27. Outpatient visit per capita Figure 28. PHC units per 100,000 pop 15.2 16 300 12.9 13 238 14 250 12 200 163 10 150 113 6.8 6.9 7.2 81 8 5.2 5.4 5.4 5.9 100 54 62 73 6 3.8 4.2 50 3 4 22 29 2.8 4 0 2 0 Li thu R om Ma c La tv B ulg ry Sl ov C ze c H un Sl ov Es t o C r oa Sw e Po rt L at v NL Bu lg R um Slo v Hun Slo v Cze c F inl a Esto Croa e do n ia an ia ga ar ia a ni a en ia ak ia n ia h Re tia g ary d en u gal aki a ia en ia a ria a nia n ia t ia hR nd ia p Source: WHO. http://data.euro.who.int/hfadb 5. Pharmaceutical spending as a share of total health expenditures are high and increasing. The recent relaxations for licensing of pharmacies; deregulations in drug procurement combined with new market entry of 10 high-price drugs contributed to raising drug expenditures suggesting a need for tighter regulation. Although the share of pharmaceutical expenditures is relatively high, per capita consumption is still lower than in Czech Republic (Figure 29, Figure 30), indicating that unless actively contained, expenditures on pharmaceuticals may continue to grow even further. The Government is advised to reinstall tight regulation of pricing and new market entry products and allow competitive market entry for generics. Health insurance companies need to act as rational purchasers, and use their bargaining position vis-à-vis the pharmaceutical companies and health providers in order to negotiate lower prices and encourage fewer prescriptions. Figure 29. Pharmaceutical expenditure, Figure 30. Total pharmaceutical PPP$ per capita, 2005 expenditures as a % of THE, 2005 450 Slovakia 31.9 400 Czech Rep 30.0 350 Hungary 29.2 300 Poland 28.0 250 Estonia 26.7 200 Spain 22.9 150 Serbia 22.1 100 Malta 22.0 50 Portugal 21.9 0 Italy 20.1 Greece Poland Belgium Sweden Slovakia Hungary Norway Austria Denmark Ireland Czech R Finland Belgium 19.3 Greece 17.4 15 20 25 30 35 Source: WHO. http://data.euro.who.int/hfadb Pay for quality instead of quantity 6. The financial incentives embedded in the current provider payment systems contribute to the current inefficient resource use. PHC providers are paid capitation, and hospitals a per-case payment. In addition, insurers reimburse specialists and 40 providers at all levels of care a fee-for-service (FFS) price for each technical service provided, and drug prescribed. FFS payment combined with a high and growing number of providers has caused a steady increase in the number of high-priced services such as CT and MRI exams (Figure 31, Figure 32). Outpatient providers should be paid a capitation rate that includes technical services and pharmaceutical expenditures and is adjusted by quality performance, and not quantity of services. Figure 31. Number of pharmaceutical Figure 32. Number of high tech services, packs (in pcs), in million in thousand 93.5 94.0 CT exams MRI exams 95 400 306.8 90 86.1 300 249.6 248.0 223.9 85 81.6 200 80 52.9 71.4 100 28.0 42.5 75 0 2003 2004 2005 2006 2003 2004 2005 2006* Source: WHO. http://data.euro.who.int/hfadb Cost pressure from future salary increases and need for capital investment 7. Future salary increases and a change in the labor code put pressure on labor costs. Wages are paid by hospitals from insurance revenues. Three major pay rises of each 10% have occurred since May 2006 resulting in a 2 billion SKK wage bill increase from 2005 to 2007. A further 10% salary increase is expected to be requested by the unions in 2008. Although, the number of health workers dropped from 2004 to 2005, a change in the labor code resulted in an increase in the number of physicians hired in hospitals. These combined effects will put substantial cost pressures on hospitals, and insurers. 8. Capital spending is ad hoc and crowded out by increasing recurrent costs. Capital spending by the MOH has decreased substantially in state-owned hospitals. The owners of the regional and joint-stock hospitals are responsible for capital investment. Limited resources resulted in a setback of project modernization. The Government is advised to explore private-public collaboration as a possibility to modernize infrastructure. Such collaboration should start with non-medical activities, including services such as laundry, cleaning, kitchen, and gardening to the private sector at competitive rates; followed by laboratory and sterilization services. A legal change to the transformation act is needed to allow regional and joint-stock hospitals to sell their assets and use resources to invest in the improvement of quality of care. Raising prices 9. There is strong upward pressure on health care prices. In late 2006, the co- payment reduction charged to patients for the use of outpatient and inpatient services has led to a price increase for health services paid by insurance companies. In January 2007, the CPI for medicaments decreased by 2.4% due to a VAT reduction on drugs from 19% to 10%. A further drop of 3.1% occurred in June 2007 due to a change in the drug basket. 41 However, these reductions were short-lived and the drug CPI has been rising steadily since July 2007 mainly because of ten high-cost drugs that have been added to the positive list (Figure 33). It highlights the need for strict price regulations for new market entry products and revisiting the generics policy to ensure competitive pricing. In January 2008, the largest insurer signed contracts with state-hospitals agreeing on a rate increase of 30%-40% per inpatient admission; and with outpatient providers with a 7% increase in the capitation rate, which will be followed by another 5% increase in April. These price increases were dictated by the Ministry of Health to improve the financial situation in hospitals and will contribute to another hike in the MCPI in 2008. Figure 33. Impact of policy changes on prices VAT 140 Basket MCPI 120 100 Medicaments co-pay 80 stop 60 Medical material Ja 6 7 6 7 Se 6 Se 7 N 6 N 7 M 7 M 6 M 6 M 7 Health -0 -0 -0 -0 l-0 l-0 0 0 0 0 -0 -0 n- n- p- p- ov ov ay ay ar ar Ju Ju services Ja Source: National Statistics Office, Republic of Slovakia Level of health care spending is not out of line but financial sustainability is under pressure by increasing expenditures and debt 10. Total health expenditures are in line with other countries: At 7.2% of GDP, total health expenditures are in line with other European countries at similar level of GDP. Similarly, the public expenditures on health was 5.3% of GDP or $ 782 per capita per year, which is within the range of the new EU member states (Table 15). In 2004, about 77% of total health expenditures came from public and 23% from private sources, which reflects the European average (Figure 34). 11. Eliminating co-payments created Table 15. Public expenditures on health, 2004 a need to look for alternative revenue sources. Formal co-payments have been in % of PPP $ per introduced from June 2003 until GDP capita September 2006 (Table 16). Combined Estonia 4 571 with other private sources they Latvia 4 482 contributed about 1.9% of GDP to total Poland 4.3 559 health care in 2004. Abolishing this Bulgaria 4.6 386 revenue source caused revenue Lithuania 4.9 633 shortfalls in hospitals, physician offices Slovakia 5.3 782 and transport units. To protect their Hungary 5.7 937 financial sustainability and compensate Croatia 6.2 743 Czech R 6.5 1,259 for this shortfall, providers have Slovenia 6.5 1,372 increased their overall revenues by (i) EU 6.5 1,778 raising prices charged to the insurance Source: WHO health for all. http://data.euro.who.int/hfadb/ 42 fund, and (ii) providing more “lucrativeâ€? services such as CTs and MRIs to cross- subsidize to less-profitable services. Figure 34. Private and public health expenditures in % of THE, 2004 100 80 60 Private 40 Public 20 0 M ac Cze NL UK Sw i Ro m Hu n Slo v L it h Italy Slo v Malt G er La t v Bu lg Sp a Belg Po la EU Es to F in l Au s F ran Cro ch R e do t zer m an in uan at i a an d gar y a t ria ia ak ia en ia iu m nd ania aria n ia ce n ia lan d ia ep y Source: WHO health for all. http://data.euro.who.int/hfadb/ Table 16. Fees introduced effective June 1, 2003, abolished in September 2006 Type of Care/Provider User Fee Per Retained at Primary outpatient care SKK 20 visit Doctor Specialized outpatient care SKK 20 visit Specialist Hospital (i.e. room and board) SKK 50 day Hospital Transport SKK 2 km Transport Prescription SKK 20 prescription SKK 5 pharmacy SKK 15´health insurance company Source: Ministry of Health, 2003 12. A new co-payment policy should ensure co-payments do not have adverse impact on equity in health financing. An analysis17 on the equity impact of out-of-pocket payments (OOP) charged from 2003 – 2006 found that co-payments caused the share of income spent on OOP to increase overall from 1.38% in 2000 to 2.95% in 2005, with lowest income groups paying almost 5% compared to the richest groups, who pay only 2% of income. Despite these increases, the Slovak OOP is still among the less regressive in Europe, suggesting that exemption policies were successful. Also, drugs account for the highest proportion of total OOP, rising from 55% in 2001 to 64% in 2005 whereas the share of inpatient services was rising only slightly, and outpatient services remained unchanged. Based on this experience - and to moderate overuse of care while ensuring equity in access - a co-payment policy should be re-introduced with adequate safeguards for the poor and vulnerable to prevent inequity in access. The effect of co-payments should be monitored to detect adverse effects on equity in utilization and financing of health care, and prevent that the poor are excluded. 17 Kiss, Stefan et al. (2007): Equity in Health Care Finance in Slovakia - the Impact of the Reform. Erasmus University Rotterdam. 43 13. Health insurance contribution rates are relatively high. Contribution rates in Slovakia amount to 14% of wage income per individual18. This is relatively high compared to 5.25% of gross wages in France; 6% in Bulgaria; and 6.9 to 9.1% in Austria. In Switzerland, premiums are paid as a per capita flat amount by households and depend on age, gender and canton of residence (Table 17). In Slovakia, the contribution rate for severely disabled is 7% of gross wage; with employers paying 5 and employees 2%. The State pays 4.5% of the average wage from two years ago on behalf of the non-working population (pensioners, unemployed, social assistance recipients) starting 2008; showing an increase from 4%. The self-employed and self-paying pay 14% of the minimum wage; however contribution evasion is high among the latter group reaching about 60%. The already high contribution rates will make it unlikely that any future health expenditure increase can be financed by increasing insurance contribution rates for employees. Table 17. Health insurance contribution rates, by Country Contribution level Austria France Slovenia Slovakia Switzerland Contribution, % of gross 6.9 – 9.1 5.25 13.45 14 Flat per capita earnings - Employer, % 3.5 94 6.36 10 0 - Employee, % 3.5 6 7.09 4 100% 14. Different contribution rates for different groups result in substantial cross- subsidies. In Slovakia, 64% of total insurance revenue is paid by 34% of the population, who pay on average 31,319 SKK per insured per year. These contributions from the labor force subsidize care of all other groups (Table 18). Analysis conducted on the equity of insurance financing identified Slovakia’s insurance financing system as progressive. However, the financial viability of a risk-pool requires actuarial management of the benefit package, suggesting a need to revisit the current contribution levels to account for different expenditure patterns, especially for the elderly and disabled. Table 18. Health insurance membership and premiums, by enrolment category, 2007 Total % of Total % of Premium per Members total premium in total insured per year, (in 1,000) insured billion SKK premium SKK Employees 1,820 34% 57.0 64% 31,319 Self-employed 375 7% 4.6 5% 12,267 State 2,956 56% 26.5 30% 8,965 Self-paying 150 3% 0.6 1% 4,000 Average 5,301 100% 88.7 100% 16,733 Source: WB staff estimates based on data from HSCA. Government regulations prevents competition among insurers 15. Tight regulation reduces the role of insurance companies to disbursement agents. Insurance companies can either compete for more and healthier members or better-performing providers. In the past year, few insurance members have changed their 18 Minimum base is the official monthly minimum wage (SKK 7,600) and maximum base is three times the official average wage (SKK 51,822). 44 insurance company, and movement among insurers occurs mainly between three private insurers, with Union losing 30% of its members who mainly went to Dovera and EZP (Figure 35, Figure 36). There is hardly any competition among insurance companies. Contribution rates are nationally defined, the benefits package is comprehensive and standardized, and contract prices to providers are similar with tariffs fixed by MOH. The new MOH minimum network plan19 includes only state-owned hospitals and forces insurers to contract with all these hospitals at a price dictated by the MOH, whereas non- network hospitals can be excluded from contracts. As a result, health insurance companies can only compete on quality and range of contracted non-networks providers, insurance administrative efficiency, and superior customer services. The new legislation abolishes the transformation of healthcare facilities into joint-stock companies, which reduces the number of efficient providers to contract with. The Government is advised to revisit these regulations to allow transformation of hospitals into joint-stock companies, redefine the minimum network plan based on an independent evaluation, allow selective contracting, and use peer pressure from more efficient providers to support sector performance. Competition also requires reducing the standardized benefit package so that insurers can offer product differentiation to members. In addition, insurers should have the possibility to influence members’ behavior and offer different co-payment plans. Figure 36. % of membership change Figure 35. Insurance members, by insurer 2007-8 4,000 2006 2007 2008 80% 67.1% 3,500 3,000 60% 2,500 40% 2,000 20% 11.2% -29.5% 1,500 -0.5%-1.3% -3.3% 1,000 0% -0.8% VZ P SZ P Ap oll D o ve EZ P Un ion T ot al 500 -20% - -40% o ra insu r Do Un VZ SZ Ap EZ v P P P ion oll ed era o Source: HCSA 16. Risk-equalization transfers across insurers partly neutralizes incentives to compete for better performing providers. Premium revenues are re-distributed among insurers monthly according to their members risk based on age and gender, and adjusted by a healthcare cost index which is based on provider invoices to insurers. The index is lowest for men (20-25) and highest for men (75-79). This measure should set a disincentive for risk selection but still leave insurers with an incentive to compete for better performing providers. The latter incentive is partly neutralized by an ex-post reallocation at the end of the year based on actual expenditures from two years prior the reallocation year, using the same methodology. In reality insurers can only benefit from this system if their risk distribution includes healthy elderly who don’t seek care, and if they reimburse providers less than what providers have invoiced. The World Bank is 19 Amendment adopted on 24 Oct. 2007. http://www.vlada.gov.sk/english/aktuality_start.php3?id_ele=7464 45 currently conducting a study on multiple insurance and competition, and will include Slovakia as a case-study. Recommendations will take into account the experience from other countries. Health outcomes are affected by insufficient quality of care 17. Poor health status causes a high rate for work absenteeism. Although Slovakia has more hospitals, beds and PHC units as well as significantly more outpatient visits and average length of stay in hospitals the Slovak health sector produces a lower life expectancy, and higher death rates for circulatory, cerebrovascular, and ischemic heart diseases, as well as a higher infant mortality rate than Slovenia and Czech Republic (Table 19), and a rather high diabetes prevalence rate (Figure 37). These rather poor health outcomes suggest that resources could be redirected within the Slovak health care system from low-efficiency hospitals and PHC units to be invested into modernizing treatment patterns and prevention of high cost disease. Slovakia reports an absenteeism rate for the workforce of 38 days of illness per year per employee, which is four times higher than the European average (Figure 38). This extremely high number indicates a need for revisiting the reliability and validity of statistical data collected in the country. Table 19. Health outcomes in new EU member states, 2005 Standardized Death Rates (per 100,000), different Infant TB causes (2005) deaths Life Incidence per 1000 Country Circulatory Cerebro- Ischemic Smoking live births Expectancy per System vascular heart Related 100,000 diseases Causes Slovakia 74 11.92 508.68 74.22 268.32 414.12 7.2 Slovenia 77 12.07 261.2 53.86 68.22 189.38 3.38* Czech R 76 10.1 419.02 109.43 177.51 359.31 3.39 Hungary 73 21.56 502.43 108.23 261.33 490.5 6.23 Estonia 72 38.69 498.17 122.94 264.18 448.56 5.44 Poland 75 22.72 384.24 87.4 114.43 238.1 6.42 Latvia* 71 65.29 563.92 171.81 279.38 511.09 7.62* Lithuania 72 61.4 562.81 123.23 354.98 548.07 6.84* EU-27 73.89 9.83 493.09 128.34 182.59 390.12 8.34 average Source: WHO, European Health for All Database http://data.euro.who.int/hfadb 46 Figure 37. Diabetes prevalence, in %, 2006 Figure 38. Absenteeism from work, 2006 8 7.40 45 38.7 7 40 5.45 35 6 4.50 30 5 25 3.373.41 4 20 1.972.252.30 11.3 11.5 11.5 12.7 3 1.74 15 8.3 10.0 10.2 10.3 2 10 1 0.07 5 0 0 EU Hu Slo L it Ne Es Au Cro Slo Lith Ro m L at Slo Swi Ukr EU Cz e F in It al to n hu the ng str vak ven at i an ary u an via y vak land a in ia tzer ch R rla ia a nia a ia ia ia nd e ia ia land s Source: WHO. http://data.euro.who.int/hfadb 18. The high smoking related mortality rate is preventable. Slovakia reports high smoking rates20. Smokers have a higher risk for diseases with costly treatment such as cancer, contributing to increasing health expenditures. While the excise taxes on cigarettes have been raised resulting in a price increase of 19% beginning in 2008, the Government should support the World Health Organization’s long term strategy and decrease tobacco consumption by introducing anti-smoking actions in public places following the example of Italy and the UK. Policy recommendations To improve efficiency, quality and the financial sustainability of the health sector, the Government is advised to play a strong stewardship role in reforming hospitals, outpatient care and pharmaceuticals, and set the supporting financial incentives: Continue hospital rationalization: Revisit the current minimum network plan based on an independent analysis, and continue transforming hospitals into joint-stock ownership. Allow regional and joint-stock hospitals to sell their unused assets and merge underutilized facilities. Introduce public reporting of quality performance results of hospitals in newspapers and on TV to stir consumer demand to better quality and more efficient hospitals. Conduct operational efficiency analysis in state-owned hospitals to identify efficiency gains in the “delivery of care chainâ€? and train staff based on modern treatment protocols. Adjust staffing-mix in State-owned hospitals based on a Human Resource strategy for the health sector. 20 A study conducted in August 2007 found that 31 % of Slovaks aged 18 and older indicated that they smoked the day before the interview. This rate was 28 % in all EU countries combined, and 24 % in the USA.: http://www.gallup.com/consulting/worldpoll/24046/About.aspx 47 Moderate overuse of outpatient care: Visit rates for outpatient care need to be brought in line with OECD averages, and one effective way of doing so is through co-payments, with transparent criteria to identify low-income groups who are exempt from payments; and charge higher co-payment levels to the better-off. Define a minimum number of PHC providers in line with the OECD average, and reduce the number of contracted providers to this level. Non-contracted providers are excluded from insurance coverage. Train providers in adherence to standard treatment protocols. Restrict pharmaceutical consumption and pricing: Pricing and prescription patterns for generic, new market entry and high-cost drugs should be regulated tightly to allow competitive market entry of lower- priced products. Charge a higher co-payment for non-generic drugs than equivalent generics. Reform provider payment Move to full capitation payment (including for pharmaceuticals and technical services), and adjust the capitation rate by few quality compliance indicators, simple to measure, to reward quality care. Report performance results publicly. Introduce case-mix adjusted diagnosis-related group (DRG) payments in hospitals with strict expenditure ceilings, and define prices for contracts based on hospital unit costs at an efficient level of production. Adjust the DRG amount by performance indicators to award shorter average length of stay and higher occupancy rates; and charge co-payments per day hospitalized. Set hard budget constraints with strict deficit control and keep hospital managers accountable for financial and quality performance; handover indebted hospitals to professional managers for restructuring and rebalancing. Support competition among insurers for better-performing providers Change the minimum network of providers to include the most efficient and best quality hospitals, based on an independent study. Allow selective contracting for all providers and for a reduced benefit package. Conduct actuarial analysis of the benefit package and revisit the current contribution levels to account for different expenditure patterns, especially for the elderly and disabled. Collaborate with the private sector: Negotiate management contracts at favorable rates with private companies for non-medical hospital services such as laundry, cleaning, kitchen, transport, etc., and for related services such as laboratory and sterilization. o For example, most of the Bratislava state-owned hospitals are in the same part of town. They could close all their hospital sterilization departments, and enter a Greenfield project with a private investor who will provide 48 their sterilization at better quality and lower price due to higher quantities. Similar contracts could be negotiated with a Greenfield project for hospital cleaning, kitchen, laundries, and transport; as well as for laboratory and high-cost medical technology. 49 Pensions 1. Slovak pension policy underwent major reforms in 2003 and 2004. The previous pension system inherited from the old Czechoslovakia had a fairly typical benefit formula with individuals entitled to 50% of the average income of the highest 5 of the last 10 years with an additional 1% for each of up to 17 additional years. But the system had contained a major element of redistribution where the lowest segment of income was counted 100% in the pensionable wage, for a second tier of income only 1/3 was included, for a third tier only 10% was included, and while contributions continued to be collected on incomes above the third tier, no additional benefit was earned at that level. 2. The 2003 reform which took effect in January 2004 adopted the German point system which closely linked contributions and benefits. Individuals earned points for each year of contribution, earning one point if contributing a full year on the basis of average wage, two points if salary were twice average wage, half a point if salary were half average wage or if only half a year of work took place at average wage. The maximum number of points in a given year was set at three, matching the maximum wage subject to contribution at three time’s average wage. When an individual reached retirement, the total points earned were monetized using a coefficient set at approximately 1.2% of average wage such that a person contributing on the basis of average wage for 40 years would earn a pension equal to 50% of average wage in the year of retirement. This pension would be increased in future years by 50% of inflation and 50% of growth in average wage. Retirement ages for men were raised from 60 to 62; retirement ages for women were gradually raised from the initial ages of 53-57 depending on the number of children to 62 which will be reached only in 2013. Contribution rates were raised slightly from the previous 28% to 28.75%. 3. A further reform followed in 2004 and implemented in 2005, which allowed current workers to choose to invest part of their contribution in privately managed pension funds which invested the money. The contributions of the individual together with the investment earnings on the individual account would supplement the public pension. In exchange for the reduction in contribution to the public system, the future benefit provided by the public system would be reduced by half. Nine points of the total contribution rate were allocated for the private accounts. Because a little less than a third of the contribution was diverted to private accounts in exchange for a 50% reduction in future public pension, the introduction of the private funded system improved the fiscal sustainability of the public pension system in the long run. In the short run, however, because revenues to the public system are reduced from the diversion of some contributions to the private system, while the number of current pensioners and their benefit levels remain fixed, the public system was expected to run deficits. Roughly two- thirds of contributors chose the private pension system, with 1.6 million contributors out of a total of 2.3 million choosing private pension funds. Current contributors were given 18 months to decide, and the choice was irreversible. New entrants were obliged to enter the mixed public-private system, and all those who did not actively choose a private pension fund were assigned to one. Figure 39 shows the fiscal impact of the two reforms compared to the pre-reform situation. 50 Figure 39: Comparison of 2003 and 2004 reforms with pre-reform pension system Pension System Balance as % of GDP 5.0% % of GDP (5.0% ) (10.0% ) (15.0% ) 2008 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 2078 Year 2003 Reform 2004 reform Pre-reform Source: Staff calculations 4. The 2003 reform was expected to generate small surpluses in the early years from the rising retirement age, the systematic indexation which was lower than the average previous ad hoc indexation had been, and with the lengthening of the averaging period for the pensionable base from the average of the highest 5 in the last 10 years to all 10 years and gradually increasing to full career as the wage histories were accumulated in the Social Insurance Agency. However, in practice, various discretionary increases have been granted in the intervening years and the public part of the pension system, even without the transition to the second pillar or private pension funds, is continuing to run deficits. 5. 2007 Amendment. While a number of legislative changes were made in the intervening years, the most critical change was made in 2007, reopening the issue of private pension funds. Those workers who chose private pension funds were given 6 months ending in June 2008 to return to the public only pension system. There were some 90,000 individuals out of the 1.6 million private pension fund contributors above the age of 47 who probably should not have chosen to belong to the private pension funds. But unlike countries like Hungary, which allowed only those above a certain age to return to the public system, in Slovak Republic the choice has been opened for all workers. Furthermore, new entrants to the labor force will now also be given a period of 6 months after joining the labor force to choose whether they want to join the private pension funds in addition to the public system or remain only with the public system, and in both the case of current workers and the new entrants, once the choice has been made, it is supposed to be irreversible. If the new entrants do not make an active choice, they will be automatically enrolled in the public system only. 6. The precise fiscal impact of this change will depend largely on what choices people make. If very few private fund contributors choose to switch back to the public system and almost all new entrants actively choose private funds, very little will change. Revenues are unlikely to rise significantly for the public system, which was one of the 51 primary motivations of the amendment, and future public pension expenditures are unlikely to rise substantially. However, in an even moderate case, small revenue gains in the short run will be outweighed by substantially higher pension expenditures in the long run, with serious implications for the fiscal sustainability of the public pension system. The fiscal impact of a moderate response is shown in Figure 40. The moderate case assumes that all those private fund contributors above the age of 47 will return to the public system, and a net 10% of private fund contributors at lower ages will also choose to return. Among new entrants, already 60% are not actively choosing a private pension fund and opting for whatever is assigned to them. If this same 60% who are not currently making an active decision continue not to make active decisions, then 60% of new entrants will remain in the public system. The impact is significant with an almost doubling of the long run pension deficit. While it may seem that the long run negative impact depicted in Figure 40 is a long way off, the substantial increase in deficits will occur about the time when today’s new entrants who are being pushed into the public system begin to retire. Figure 40. Projected Public Pension System Finances Under Moderate Assumptions with 2007 Amendment Pension System Balance as % of GDP 2.0% % of GDP (2.0% ) (4.0% ) (6.0% ) 2008 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 2078 Year 2003 Reform 2004 reform 2007 Amendment Source: Staff calculations 7. Urgent need for further reforms to public pension system. Prior to the 2007 amendment, the Slovak authorities were aware of the need for further reforms to the public system. However, in light of the substantial changes which had been undertaken, the decision was made to delay further reforms until people had absorbed the first round of changes and felt more comfortable with their new pension system. But given the increased long run costs associated with the 2007 amendment, the need for pursuing these reforms has become more urgent. 8. The reforms which need to be undertaken relate to the benefit structure in the public system, the pensions paid by the Social Insurance Agency. International best practice suggests that pensions post-retirement be indexed to inflation only. Currently, pensions in the Slovak Republic are legally indexed 50% to inflation, 50% to average wage growth, resulting in a much higher indexation than is fiscally sustainable, and the 52 actual indexation in some of the years post-reform was even higher. The move to inflation indexation should be enacted as soon as possible, phased in over the period 2009-10. 9. Secondly, the retirement age for men currently stands at 62, while the retirement age for women is rising to 62, and will be reached around 2013. International best practice suggests that minimum retirement ages for both men and women should be 65 and should rise gradually from there in line with longevity increases. The rise in retirement age could wait until women’s ages are equalized with men’s ages and then could be phased in at the rate of a rise in age of 6 months per calendar year which would require 6 years for the three year increase in age to become fully effective. From that point forward, the retirement age should be raised in line with longevity increases, at a rate of roughly 1 year in age each 20 calendar years. 10. The impact of these two measures is shown in Figure 41. Had the 2003 and 2004 laws been implemented as they were originally legislated, these two measures would have been sufficient to bring the public pension system into long run balance. However, as Figure 41 shows, with the 2007 amendment, even these two measures are insufficient to achieve long run fiscal sustainability. And in addition to the 2007 amendment, other changes have also been enacted since the original legislation was passed which add to the cost of the public pension system, in addition to what is shown in Figure 41. Figure 41. Fiscal sustainability of public pension system with additional parametric reforms Pension System Balance as % of GDP 2.0% % of GDP (2.0% ) (4.0% ) 2008 2013 2018 2023 2028 2033 2038 2043 2048 2053 2058 2063 2068 2073 2078 Year 2004 reform 2007 Amendment Ret age+indexation Ret age, index&reduced benefit Source: Staff calculations 11. A third measure, a reduction in target benefit rates, would be required to bring the system into long run balance. Reducing the target benefit rate from 50% of average wage to 40% of average wage, to be gradually phased in between 2020 and 2040, when combined with the other measures would be sufficient to bring the system into long run fiscal sustainability. It is unfortunate that those private pension fund contributors who are being encouraged to return to the public system will then find the benefits provided by 53 that public system to be reduced by the time they are ready to retire, but this measure is required to bring the system back toward fiscal sustainability. 12. A possible fourth measure, a rise in contribution rates, should be ruled out since the current contribution rates in Slovak Republic are already at least 25% higher than the western European average and also higher than some of the central European countries. As wage convergence with western Europe proceeds, the higher payroll taxes in the Slovak Republic will begin to affect the competitiveness of Slovak industry, and further raising payroll taxes at this juncture will only make the situation worse. 13. Another measure which should be avoided is a reduction in contribution rates to the private system in an effort to boost the revenues of the Social Insurance Agency. Many of the New Member States21 which have adopted the funded system are raising contribution rates in the private pension funds rather than reducing them in an effort to improve pensions for future workers. Constrained by fiscal sustainability and an aging population, public pension systems are no longer able to provide generous pensions. Contributions made to private pension systems can earn higher rates of return and can offer better pensions for the same contribution than the public system. 14. In addition, in the Slovak case, 9 percentage points of wage out of a total of 28.75% of wage which covers old age, disability, survivors, and a reserve fund are dedicated to private pensions. Thus, 31% of the total contribution goes to private pension funds, but individuals give up 50% of their public pension in exchange. Already this means that the private pension funds need to pay a rate of return 60% higher than the public system in order to prevent the individual from being worse off. Should the contribution rate to private pension funds fall to 6%, for example, without any adjustment in the public benefits, the private pension funds would need to pay two and a half times the rate of return of the public system for individuals to be equally well off. The private pension funds would never be able to achieve such high rates of return, leading to future public pressure to allow another return to the public system. This would be equivalent to stopping the reform process with the 2003 reform law. But from Figure 39, it is clear that in the long run, had the reform process in Slovakia stopped with the 2003 reform and not proceeded to the 2004 reform, the system would be less fiscally sustainable than it is now. Alternatively, the public system could agree to pay a higher percentage of the public pension to those who joined the private system with reduced contributions, but this again raises public system expenditures, and exacerbates the problem rather than solving it. 15. This analysis does not suggest that there are no problems in the private pension system. Clearly older workers who may have mistakenly joined the private system need to be allowed to switch back. Young workers with low wages should not be encouraged to switch back because over their lifetime these workers should earn higher wages. Rates of return in the private system could be improved, but the National Bank of Slovakia has been modifying the regulatory framework to encourage better risk management in the private pension funds. Reducing the number of participants in the private pension funds works against improving returns and service to participants. Reducing the size of the 21 These include Hungary, Latvia, and Lithuania. 54 accounts in addition to the number of participants, as would happen if contribution rates to private pension funds are reduced, only makes this worse. 16. Developing a strategy to guide further reforms in the pension system. Pension systems are different from most social benefits in that they are not generally poverty- based systems, but require contributions and in return for those contributions, provide benefits linked, not to need, but to contributions or wages. The two main objectives of a pension system are to prevent the elderly from finding themselves in poverty and to provide a means to replace the income which an individual used to earn when that individual is unable to work whether due to old age, disability, or death. 17. But there is a trade-off between these two objectives. Should the pension system focus too much on poverty alleviation, middle and higher income people will consider their contributions to be a pure tax, and will try to minimize that tax by underreporting earnings and hours. There are numerous examples of middle and even high income countries, both within and outside Europe, where a larger than expected percentage of taxpayers report and pay contributions on minimum wage alone or avoid the contributory system altogether. 18. Should the pension system conversely focus too much on providing workers income replacement, there is a risk that some elderly will face poverty when they are unable to work. Low income workers with non-continuous formal sector employment and therefore non-continuous contribution history are especially likely to face this kind of poverty. 19. The appropriate balance between these two objectives varies from country to country depending on history and preferences. Countries who want to insure poverty alleviation for the elderly frequently finance additional social assistance to the poor elderly directly from the budget rather than distort contribution incentives for middle and higher income workers. This social assistance would ideally be means-tested to make efficient use of scarce resources, although the means test chosen can be defined either broadly, so that many of the elderly receive the benefit or narrowly, so that only the very poor receive it. Some countries have also chosen to provide a social benefit of the same amount for all elderly, regardless of income, to be supplemented by the contributory system for those who have contributed. The latter, while less efficient, avoids the stigma of means-testing for the elderly and is easier to administer. 20. The previous government in the Slovak Republic initially set out a clear strategy of separating social insurance from social assistance. Pensions were to be strictly linked to contributions. Some social categories like mothers raising children were to be given pension credit, but in this case the state would cover contributions. Minimum pensions were eliminated and should pensioners fall below the poverty line, they like working age individuals could receive social assistance from the state. Given the high level of redistribution in the inherited system, a three year transition period, between 2004 and 2006, was chosen to prevent sharp differences in pensions between those who retired before 2003 and those who retired afterwards. 55 21. Nevertheless, even under the previous government, almost as soon as the legislation became effective, elements of social assistance began returning within the social insurance system. In 2004, pensions were increased differentially, with lower pensions receiving larger increases, while higher pensions received smaller or even no increases. Later, legislation was passed allowing parents to reduce their contribution rate by 0.5% for each dependent child without a reduction in their benefits. The unemployed were allowed to retire up to a year early with no reduction in benefits. The phase-in period for strictly relating contributions to benefits was extended from the original 3 years to 11 years. Some of these legislative changes were later rescinded adding to the constantly changing policy. 22. The current Government added its own measures, including Christmas bonuses for pensioners, under which those with the lowest pensions received the highest bonuses while those with the highest pensions received nothing. Most recently, the 2007 amendment raised the contribution ceiling to 4 times average wage, while the pensionable wage remains at 3 times average wage. 23. All of these ad hoc measures have at least two negative consequences. First, they add significant amounts of uncertainty regarding what people should expect to receive and when and in return for what obligations when the major rationale behind government provision of pensions is to provide security to people who are unable to work. The typical response to this type of policy uncertainty is for people to begin to distrust any government promises and to begin saving for themselves and avoiding contribution obligations to the extent possible. Second, the prevalence of these ad hoc measures leads to a politicization of pension policy, where people realize that they do not have to pay higher contributions to get higher pensions. They just have to complain to politicians and they will get their pensions increased. Both of these effects undermine public confidence in the pension system which leads to contribution evasion and a significant loss in revenue. 24. Given the historical context of the Slovak Republic with its previous highly redistributive pension system, it may be that the strategy chosen by the previous government is not politically appropriate or viable. Or it may be that the current Government has different preferences from the previous one. Nevertheless, it is important to have a pension and social benefit strategy, whether or not it is the same as the previous government’s strategy. This strategy can then guide the future reforms to fulfill the objectives of that strategy rather than adopting a series of ad hoc measures which are inconsistent and contradict each other, are often temporary, and tend to undermine confidence in the pension system. 25. At least three different options exist: (1) transform the current public component of the pension system into focusing on poverty alleviation, leaving the income replacement to the private component, (2) divide the public component of the pension system into two parts, one of which provides a basic pension to all citizens, the other part providing income replacement, with the private component continuing to provide income replacement, and (3) a return to the previous government’s strategy of focusing the 56 contributory pension system exclusively on income replacement while poverty alleviation is achieved through separate social assistance. 26. The current Government appears to be favoring the first strategy and moving back toward the inherited Czechoslovak system. But under that system, whether workers had an incentive to contribute to the system did not matter, and since employers made the bulk of contributions, people did not necessarily link their contributions to their benefits and could not object when pensions were more equal than wages. In the context of a market economy, income replacement is important. If the public component is focusing more on poverty alleviation, then the private component which focuses exclusively on income replacement becomes even more important, so that the combined system can achieve both objectives. But while moving the public component toward poverty alleviation, the Government at the same time is downplaying the importance of the private component by allowing people to opt out of it, which leaves the income replacement objective of the overall pension system unachievable. This type of inconsistent policy will only lead to disappointing policy outcomes which will lead to more ad hoc measures which will only serve to further undermine public confidence in the whole system. 27. The Government should focus first on developing a strategy for providing pensions and other social benefits as well. This strategy needs to be communicated to the public and accepted by the public. Once accepted, this strategy needs to serve as a guide for future reforms. 28. Conclusions. The 2007 amendment generates limited short run fiscal savings for the public pension system while creating substantial fiscal deficits in the long term. This long term deterioration makes the need for reform in the design of the publicly provided benefits more urgent, namely (i) a change in indexation of pensions to inflation only, (ii) a rise in the retirement age to 65 for both men and women with further rises linked to longevity increases, and (iii) a reduction in the target replacement rate for full career workers from 50% of average wage to 40%. The prevalence of ad hoc measures since the major reform legislation was passed undermines public confidence in the pension system and threatens its viability. The Government needs to develop a strategy for pension provision, communicate this to the public, and use it to guide further reform measures. 57 Agriculture and Rural Development I. SYNTHESIS 1. As an EU member state, Slovakia does not longer operate an autonomous agricultural and rural development policy, but nationally implements and manages the European Union's Common Agricultural Policy (CAP). As CAP is subject to an extensive common European regulatory framework, Slovakia's autonomy in adjusting support provisions and levels is limited. Financing for agricultural and rural development programs is provided from three European funds and complemented by State Budget resources. EU Agricultural and Rural Development Funds account for about 40-50% of total national EU Funds inflows. 2. From a current perspective, Slovakia operates a highly efficient CAP implementation model: As a result of significant reform and rationalization of administrative structures, Slovakia’s CAP implementation model is highly cost-effective. The single22 Agricultural Paying Agency (PPA) reports CAP administration costs of about 1% (i.e. one Eurocent cost per Euro support transfer). This compares to about 3-4% in other high-efficiency countries such as Hungary and Latvia, and to about 5-7% as average among many EU member states. Some of those New Member States (NMS) having chosen a two-paying-agency-approach are estimated to have administration costs of around 10% and above. While the relative cost of CAP administration in Slovakia are projected to further decline as a function of the projected increase in transfers along the negotiated phasing-in schedule, any further rationalization potential can only be realized if investments into electronic application systems and remote controlling techniques would/could be conducted. As a result of a relatively well-defined, -prioritized and –targeted National Rural Development Plans (NRDPs, for both the programming periods 2004-06 and 2007- 13), Slovakia’s CAP implementation model provides targeted beneficiaries with a equitable access to support opportunities under both CAP Pillars. A strong emphasis on area-type payments to less favored areas (LFA) and agri-environmental measures sufficiently complements the investment support measures. While Axis 1 measures, in many EU member states, are predominantly absorbed by enterprises in higher-yield regions, emphasizing Axis 2 measures ensures equitable access for enterprises in Slovakia’s (semi-)mountainous regions. As a result of the advanced implementation and strict enforcement of a performance- based program budgeting approach, the effective monitoring and management of the performance of budget positions contributes to a high degree of results orientation in budget execution. 3. From a strategic perspective, however, the outstanding cost-effectiveness might come at the high price of foregoing further efficiency enhancements. Following a 22 Comparisons across the NMS has shown that countries with single intervention and paying agencies report lower administrative cost than countries having established separate paying agencies for the two European agricultural funds. 58 period of budgetary and functional consolidation in the agricultural administration and in related budget-supported institutions, limited options exist to address the following: Limited fiscal space and flexibility within the agricultural budget chapter. A dominating 80% of the 29.2 billion SKK budgetary funds in the budget Chapter 27 – Agriculture and Rural Development represent EU-funds managed under the agricultural budget and mandatory national counterpart financing for the rural development program. The support envelopes for measures under these two funds are programmed until the year 2013 and provide no short- to medium-term scaling potential. The remaining about 20% can actually be flexibly managed by the Ministry of Agriculture. However, several financing requirements in these areas are semi-fixed (e.g. wages and related contributions). Any budgetary adjustments in reaction to contingency funding needs (e.g., natural calamities, disease outbreaks), required investments in the agricultural administration and related institutions, as well as any further budgetary consolidation would thus have to be conducted within the fiscal space of the remaining flexible state budget23. Unsustainably low levels of capital spending. In a short- to medium-term perspective, most of the state budget allocations are semi-flexible at best. The single most flexible element is the agricultural administrations operating and investment budget including the funding of institutions associated to the Ministry of Agriculture. As budget assignments from the Ministry of Finance do not predetermine a minimum capital spending share, allocations have consequently been partially crowded out24 by (i) past budgetary consolidation and (ii) the political desire to maximize transfer payments from the state budget. The currently low allocations translate into suboptimal investment in required updates of facilities, information technologies, and human capital. In fact, current practices lead to disinvestment in central, regional and associated units and might endanger future quality of service provision and compliance with EU-related management and reporting requirements. 4. Potential short- to medium-term solutions to increasing budget flexibility and satisfying investment needs exist within the budget. The available resources, however, are currently employed to provide additional topping-up payments in addition to the Direct Income Support assistance financed by European Agricultural Guarantee Fund (EAGF). 5. Though Slovakia’s topping-up of EU direct income support payments via Complementary National Direct Payments (CNDP) is exemplary with regard to the highly transparent and simple programming of applied mechanisms, the current CNDP levels should be revisited. A reduction of CDNP levels represents the most significant potential to address short- to medium-term investment needs exist within the agricultural state budget allocation. The national topping-up of EU direct payments, 23 Due to the mandatory nature of the EU-funded transfers, any 1% reduction attempt in the overall agricultural state budget contribution would therefore translate into a 5% reduction in the remaining flexible elements. Would current CNDP levels be maintained, a 1% state budget reduction would even reduce the available operating and investment budget by close to 10%. 24 In 2008, only 0.11 billion SKK (0.3% of the overall budget) have been allocated to capital spending and represent an inappropriately small share of the 3.57 billion SKK (12% of total) operating and investment budget. 59 however, is subject to strong lobbying pressure and would require strong political commitment. 6. Providing maximum top-ups would have been more justified during the initial years of membership than it is nowadays. While Slovakia had not exhausted the maximum permitted topping-up levels during the first three years of EU membership (i.e., when initial EU payment levels were much lower than today), Slovakia has decided beginning in 2007 to top-up direct payments to the maximum permitted level (i.e., 30% of EU-15 average). The move to maximum levels was taken in attempt to increase/generate agricultural profits, to harmonize support levels with other EU member states, and to partially compensate for lower-than-anticipated increase in EU direct payments following the appreciation of the Slovak Koruna. 7. Sector analysis implies that CNDPs at maximum levels are no longer required to safeguard agricultural incomes. This applies particularly in the current environment of increasing market prices for agricultural produce and a continuing progressive phasing in of EU support payments. Full CNDPs could still be considered an important tool to provide agricultural enterprises with support funds in view of enhancing their profitability and creating investment incentives. Since, however, a topping up to maximum levels is not affordable from a budgetary point of view, it is recommended that a gradual phasing out CNDP starting 2009 be considered. Such phasing out of CNDPs could still be designed so to ensure increasing support transfers to farmers. A phasing-out of CNDPs by 7.5% of EU-15 annually starting in 2009 would be positively overcompensated by the scheduled phasing-in of EU direct income support payments by 10% of EU-15 average. This would induce a 2.5% increase in direct income support payments per year, but would free up about 255 million SKK annually (corresponding to 250% of the current capital spending allocation). In case of Slovakia joining the Euro zone in 2009, the risk of exchange rate-induced reductions in nominal support payments would be eliminated. 8. Limited further potential for efficiency enhancement exists in the provision of State Aid (0.34 billion SKK) to the agricultural sector. Recommendations, however, focus on enhanced coherence of the objectives, programming, and results monitoring framework. The appropriateness of the general support areas and budgetary allocations was confirmed. 9. Two areas are recommended for further assessment as they might relate to areas of cross-sectoral efficiency enhancement: Land taxes levied on agricultural land are municipal taxes, and municipalities have reportedly a strong discretionary power in setting land taxation rates. In the interest of transfer efficiency, it is recommended to assess whether a national framework be developed that limits the range of tax rates with a view to reducing the strong regional variation of the impact of this taxation on agricultural incomes and subsequent support needs. Social security contributions in for individual farmers are based on the income (profit) declarations submitted. Farmers declaring losses contribute based on national minimum wage. It is recommended to assess whether this practice leads to intentional understatement of income from farming activities for purposes of tax/contribution 60 avoidance and whether a more appropriate basis can be established (e.g., contributions based on a standard gross margin approach). II. PROGRAM BUDGETING FOR AGRICULURE & RURAL DEVELOPMENT – STATUS AND CHALLENGES 10. For the CAP programming period 2007-2013, and in accordance with CAP funding and financial management principles25, Slovakia finances agricultural sector support through three26 main sources of funding: European Agricultural Guarantee Fund (EAGF), fully financing direct income and market support measures under the first pillar of the CAP. For its core activities, EAGF provides finance in the context of shared management between Slovakia and the European Commission (EC). For a limited number of accessory activities (e.g., specific veterinary measures for disease eradication, promotion of agricultural products, agricultural surveys) EAGF finances expenditure in a centralized manner. European Agricultural Fund for Rural Development (EAFRD), financing, in a context of shared management between Slovakia and the EC, the EC's contribution to the rural development program implemented in Slovakia27. Public counterpart financing to EAFRD allocation is provided through allocation in the Ministry of Agriculture’s budget. Budget of the Ministry of Agriculture (MoA), and the sub-ordinated Agricultural Paying (and Intervention) Agency. Financing from national budgetary sources applies to (i) the public counterpart-financing for expenditure incurred under the EAFRD; (ii) Complementary National Direct Payments (CNDP); (iii) State Aid to agriculture and rural development; and (iv) the national administration of the above where subject either to national management or shared management between Slovakia and the EC. 11. Budgetary spending for agriculture and rural development is conducted in the framework of a program budgeting approach. Budget Chapter 27 Agriculture and Rural Development is divided into five separate and exactly specified programs28: Policy Creation, Regulation and Implementation: Program supporting the implementation and management of agricultural and rural development policy including budgetary spending on the main bodies of the agricultural administration and support services. Support to Competitiveness of Agriculture and Food Sector: Program comprising the main tools of CAP Pillar I support (direct payments and market measures), agricultural knowledge and information systems, and breeding and control activities. 25 See particularly Council Regulation (EC) No. 1290/2005 of June 21, 2005, on the financing of the Common Agricultural Policy 26 A fourth principal source of budget funds is the European Fisheries Fund. Support measures under this fund, however, have not been subject of the mission’s assessment. 27 Rural Development Program following the programming and financial provisions of Coucil Regulation No. 1698/2005 of September 25, 2005, on support for rural development by the European Agricultural Fund for Rural Development (EAFRD). 28 See e.g., Green Report, 2007 61 Rural Development: Program comprising the main tools of CAP Pillar II support, including support under Axis 1 (competitiveness), Axis 2 (agri-environment), Axis 3 (quality of life), and Axis 4 (LEADER). The program provides for a strong focus on support to less favored areas. Food Safety, Health and Protection of Animals and Plants: Program comprising financing of the regulation, formulation and performance of veterinary and phytosanitary services. Sustainable Forestry: Program comprising support to forestry under the EU Structural Funds; restoration, development and research services for sustainable forestry. 12. All national counterpart financing for EU agricultural support programs is budgeted for in the agricultural chapter. From a point of view of fiscal space management in line ministry budgets this is a best practice approach29. As is discussed separately below, the budgetary allocations and projections for counterpart financing are appropriately structured and dimensioned. 13. An ‘exception’ to general budgeting of all transfers under the Ministry of Agriculture’s budget is the treatment of financial resources for market intervention and export refunds that are financed through extra-budgetary accounts. This account separation responds to the specific nature of CAP market support measures in which all relevant expenses are funded entirely through the EAGF. EAGF funds are disbursed on a reimbursement basis - the national extra-budgetary accounts operate, after their initial capitalization, as revolving funds. While the execution functions for related expenditure lie with the Agricultural Paying Agency, the financial management of these accounts is being conducted centrally by Treasury30. 29 Two models exist across the EU: (1) Budgeting of national counterpart financing resource in the relevant managing authority’s (mostly national line ministry) line budget; (2) Budgeting of national counterpart financing under a separate national fund (mostly under Ministry of Finance). 30 With current increases in agricultural market prices, no significant intervention in agricultural product markets has been conducted in 2006 and 2007 and it is projected not to be significantly triggered in 2008. The current capitalization of the extra-budgetary account of about 1 billion SKK does not generate interest revenue to the Ministry of Agriculture budget. It is recommended to review whether interest generated on this account in its central financial management could be allocated to the creation of an investment/contingency reserve in the agricultural, food, and rural policy domain. 62 Figure 42. Support Funds Flow – Agriculture and Rural Development EAGF – European Agricultural Guarantee STATE BUDGET EAFRD – European Agricultural Fund Fund for Rural Development EFF – European Fisheries Fund Direct Payments CNDP – State Aid Complementary National Rural Development OP. National Fisheries National Direct Program SR 2007-13 Program 2007-13 Payments C C SAPS: Single Area O O Payment Scheme Breeding / Herd Book U U N Axis 1 N Arable Crops T Competitiveness T Axis 2 Payment E E Aquaculture, processing Animal Waste and marketing R R Special Sugar Removal and Axis 2 P P Payment Disposal Rural Environment A A Hops Payment R R Axis 3 Measures of Insurance Payments T Axis 3 Quality of Life T Common Interest in Agriculture F Payment for I F Energy Crops Tobacco Payment N Axis 4 Leader I Axis 5 TA A N Calamity and Disaster N A Assitance C N E C Livestock Payment E Other Market TRHOVO Support ORIENTOVANÉ VÃ?DAVKY Measures Publicly beneficial activities in agriculture Vývo refunds Exportnáhrady Counterpart Finance Závodisko Å¡.p. Národný žrebÄ?ín Å¡.p. Hydromeliorácie Å¡.p. Plemenárske služby Å¡.p. Intervention IntervenÄ?né nákupy purchases Ministry of Agriculture Agricultural Paying Agency Final Beneficiary 63 14. A review of overall program budget management displayed that the actual drawdown of budget funds was largely identical to the programmed (adjusted) budgetary allocations. The high quality of budget management under the agricultural chapter is partially a function of the advanced financial mechanisms implemented as part of the CAP financial management obligations. Moreover, it is also attributed to (a) the relative ‘predictability’ of budget requirements due to the long-term programming nature of the EU CAP programming period (current period 2007-13) and (b) the performance- based program budgeting in the Ministry of Agriculture. 15. From both an inter-sectoral and international perspective, the implementation of a performance-based program budgeting system in the Ministry of Agriculture is at an advance stage. All budget lines in the agricultural budget are associated to underlying performance indicators (most of them of qualitative nature). Progress towards target realization is closely monitored. Mid-year reviews assess progress towards target achievement. Activities in risk of underachievement are being put under close monitoring and management supervision. A sanction system for non-performing budget a position is in place and also applies to subordinated or associated institutions that receive budget support. Budget supported agencies and institutions face the risk of having to return budgetary contributions in the case of non-achievement of defined targets stipulated in their performance-based contracts; discontinuation of budget support might be the consequence of repeated underperformance. Overall, the strict enforcement of performance-based program budgeting has substantially contributed to the quality of the monitoring and management of the agricultural budget chapter. 16. However, as the current practices are a relatively new budget management approach, further improvement potentials for performance-based budgeting exist. The quality of application and management of performance targets is, not surprisingly, the highest for those programs that are entirely or pre-dominantly financed via EU agricultural funds and for performance-based contracts with associated institutions. Further improvements are, however, particularly required in the performance- monitoring and management of State Aid. The definition of key performance indicators in this area requires refinement as, for instance, the applied indicator of a 100% satisfaction rate among benefiaries is insufficient to monitor a highly fragmented, multi- objective, and multi-faceted set of support measures. 17. Applying the above-listed approaches and management processes the Ministry of Agriculture administers an approved budget of 29.2 billion SKK. The significant increase over the 2006/2007 occurs mainly as a result of the beginning of a new CAP programming period 2007-13 for which fund receipt begins in 2008 after the recent approval of Slovakia’s National Rural Development Plan by the EC (incl. funding for 2007 under the n+2 rule). Secondly, 2008 represents an overlap of the remaining execution of the EU funds allocations under the previous (2004-06) programming period for rural development funds and the current, new programming period (2007-13). Finally, the scheduled increase in direct payments from the EAGF continues at a rate of 10% of EU-15 average. The higher EAGF and EAFRD allocations are also the main factor behind the increased level of budget projections for the future two budget periods (2009 and 2010). 64 18. Despite the above-discussed Figure 43. Budget, Chapter 27 -Agriculture, accuracy and appropriateness of the 2006-2010 budget projection process, the 30 budget projections for 2009 and 2010 are potentially [billion SKK] underestimating the factual 20 funding requirements for support payments under the agricultural 10 chapter by up to 3.5 billion SKK per year. While a strong political commitment has been made by the 0 Ministry of Agriculture to continuing 2006 2007 2008 2009 2010 the topping-up of EU direct payments, the funds required for * estimates for 2009/10 CNDP are not factored into the budget projections. The indicated reason is that CNDPs are approved on an annual base by Governmental Ordinance and that, therefore, no current legal base for a projection of CNDP Table 20. 2008 Agriculture budget structure, simplified payments in 2009 and '000 SKK % beyond exists. In an attempt to improve this EU resources: (EAFRD) - rural development 18,734,495 8,776,607 64.3 30.1 major gap in budgetary - rural development (EAGGF) 2,359,567 8.1 projections, it is strongly - direct payments (EAGF) 7,577,031 26.0 - FIFG 21,290 0.1 recommended that a National CAP-related transfers: 6,782,333 23.3 dialogue on the - pre-financing of direct payments 278,886 1.0 - counterpart financing of rural development (EAFRD) 2,415,293 8.3 envisaged future levels - counterpart financing of rural development (EAGGF) 664,654 2.3 of CNDP be initiated - counterpart financing - fisheries (FIFG) 9,899 0.0 and a multi-annual legal - CNDPs 3,413,601 11.7 Other national resources, of which: 3,602,709 12.4 base be created. This - wages 968,653 3.3 would not only benefit - state aid 368,000 1.3 - capital expenditure 108,800 0.4 and rationalize the projection of flexibility TOTAL: 29,119,537 and investment potentials Source: in the state budget segment of the agricultural budget (see separate discussion), but also enhance the ability of the agricultural sector to anticipate developments in support funds receipt. 19. As discussed in the synthesis section, a revision of current practice of providing CNDPs at maximum is considered a central element in enhancing: Fiscal space and flexibility within the agricultural budget to safeguard sustainable investments in the agricultural administration and associated institutions. Failure to address this in the short- to medium-term might endanger further efficiency enhancement in the provision of public service provision to agriculture and rural development and consequently induce adverse spill-over effects on sectoral competitiveness. 65 Fiscal space and flexibility to react to contingency funding requirements (e.g., calamities, desease outbreaks). Extremely limited budgetary sources and mechanism are available to address such non-predictable financing needs. It is therefore recommended that in addition to revising CNDP levels, an analysis be commissioned on whether/how required fiscal reaction potential could potentially be provided through establishment a contingency reserve funding mechanism. Given the cross-sectoral issues imposed by such emergency situations and considering that fragmented line-ministry specific contingency reserves might bind inadequately high public funds, the establishment of a cross-sectoral mechanism might be considered. From a perspective of current agricultural programs, contributions to capitalizing such fund could be drawn from current CNDP allocations and the funds/interest of the extra-budgetary accounts for market intervention and export refunds. III. SPECIFIC PROGRAM ASPECTS 20. Slovakia has one of the best performing farm sectors across the EU New Member States. In 2006, agriculture contributed about 4.2% to GDP and employs 4.4% of a relatively young labor force (65% at ages between 15 and 49). Large and mostly efficient corporate holdings dominate the sector. Farms bigger than 50 ha operate 95.8% of the agricultural land and average 1,372 ha. EU-funded Direct Payments – Single Area Payment Scheme (SAPS) 21. Like most of the other new member states, Slovakia chose to use the simplified implementation system, the Single Area Payment Scheme (SAPS). Fully financed by the European Agricultural Guarantee Fund (EAGF) it provides for area-based payments that are decoupled from production activity. Slovakia was initially scheduled to move from this simplified to the EU mainstream single payment scheme (SPS) in 2009, the EU has recently extended the applicability of SAPS to 2013. This decision has been taking the light of several advantages such as reduced costs of implementation, administrative simplicity, and a smaller distortive effect on the farm sector. 22. Payment volume and levels to farmers are subject to an EU-regulated gradual increase ("phasing in") over Figure 44. Real and nominal SAPS phasing in, 2004-13, starting from about 2004-07 [2004=1.0] 1,750 SKK/ha in 2004 and being projected for the current 1.50 year to about 3,400 SKK/ha (100 EUR/ha). The recent appreciation of the SKK 1.25 however, impacted nominal domestic SAPS support rates and thereby somewhat eroded the nominal phasing-in effect. 1.00 2004 2005 2006 2007 The SAPS payment volumes are established in EUR, while SKK EUR payments to farmers are then * estimates for 2009/10 made in the national currency of 66 each member state. Following the appreciation of the SKK, the nominal area-payments in SKK have been lagging behind the anticipated phasing-in schedule. Nationally-funded Direct Payments - Complementary National Direct Payments 23. Slovakia has been granted the option to (partially) employ national budgetary resources to "top-up" EU direct income support via Complementary National Direct Payments (CNDP). This is a transitional option and is subject to an EU-agreed phasing out schedule. Starting 2010 at the latest, top-ups are being gradually replaced by the phasing-in SAPS payments, and must be discontinued in 2013 when the single area payments eventually reach 100% of the EU-15 level. 24. Slovakia has designed one of the simplest and most effective CNDP regimes across the EU-12. After accession Slovakia chose to implement 5 distinct CNDP schemes31 that were further consolidated into 4 in 200732. Last year, the specific animal premia (for suckler cows, sheep and goats) were unified into a single livestock regime, with subsidies payable per livestock unit. Until 2007, the Slovak top-ups were almost entirely (90%) paid to arable crops, as “flatâ€?, area-based payments similar to the SAPS. The transfer efficiency of this particular CNDP design is very high, because it: (1) is the least economically distortive of all CNDP options; (2) requires relatively low administrative efforts; (3) has positive spill-over effects on income from livestock due to eligibility of fodder crops (e.g. barley). 25. Though highly effective, the broadening of the livestock support CNDP has come with a major increase in the overall CNDP financial envelope. In the years following accession, Slovakia had not even exhausted its maximum permitted topping-up levels (i.e. 30% of the EU-15 level). The actual topping up levels even decreased from 24% (2005) to 19% (2006). This also translated into a reduction of the CNDP annual envelope, from 80.9 million EUR equivalent (2005) to 68.6 million EUR equivalent (2006). But a major increase was decided in 2007 when the total top-up volume reached the ceiling of 30% of the EU-level (or 114.9 million EUR). The increase was mainly driven by the decision to strengthen support to the livestock sector. The livestock regime was allocated a budget of 54.3 million EUR, a 7-fold increase compared to the cumulated previous animal regimes. Conversely, CNDPs to arable crops were reduced by 18% since 2005. 26. The resulting budgetary pressures became even higher as the possibility to use EU-funded rural development resources for top-up payments elapsed. As part of the EU accession agreement, the new member states were allowed to shift (“reverse- modulateâ€?) an amount of Pillar 2 money and use it for supplementing the CAP direct income support provided through Pillar 1. This opportunity was limited to 2004-06, as over these years, the SAPS levels would have already substantially increased. Slovakia made use of this opportunity during the first three years of accession, thus alleviating the budgetary pressure deriving from its decision to top-up. Topping up to the maximum 31 Arable crops, tobacco, hops, suckler cows, sheep and goat. 32 The majority of new EU member states opted to direct their complementary payments preferentially towards selected categories of agricultural producers. In some of them, as many as 10 product-specific regimes were introduced for that purpose. 67 level in 2007 (30% of the EU-15) coincided with the termination of the reversed modulation, and had to be provided entirely from the national budget. 27. From a farmers’ income perspective, providing maximum top-ups would have been more justified during the initial years of membership than it is nowadays. A World Bank study33 concluded that top-up payments to arable crops were not needed, even in the first years of membership, to preserve the pre-accession incomes of farmers. The phasing-in of the EU direct payments and the recent increases in market prices for crop products further emphasize these findings. 28. However, the same study found that the activity-/product-specific CNDPs buffered negative income impacts in activities traditionally conducted in low-income regions (suckler cows, sheep and goats, and hops). Yet no need to increase current and/or implement additional specific CNDPs was identified. Most farms in Slovakia obtain substantial transfers in the form of less favored areas (LFA) payments funded from well- targeted CAP Pillar 2 allocation. Besides, to increase competitiveness, targeting the CAP investment support through CAP Pillar 2 to livestock and other producers is more effective than CAP Pillar 1 income support measures. Figure 45 Relative income effect of Figure 46. Relative income effect of accession per ha/head (with SAPS but accession per ha/head (with SAPS and without CNDP) CNDP) 500 500 percent change in VA per ha/head percent change in VA per ha/head 400 400 300 300 200 200 100 100 0 0 -100 -100 s P k ow t s i lk ze tl e y ga s o Ba t s ap ye y ee To r a s at s Su eed C eet i lk P k ze l e ttl e & ry r ltr o Su Hop ga s s cc at rle ow y ap Rye e To er Po at m he Su ed r cc Su Hop ai ow c k Cat r le R w Po go lt m he e e ou rb ai ba w go M ck Ca rb e e ou rC lo e W ba es M Ba rC lo ow W es & nf nf le C p p R R Su Sh Su Sh '04 rel to '02/03 '05 rel to '02/03 '04 rel to '02/03 '05 rel to '02/03 29. It is, however understood that while not needed to safeguard agricultural incomes, the move to the CNDP maximum levels was taken to increase/generate agricultural profits, to harmonize support levels with other EU member states, and to partially compensate for lower-than-anticipated increase in EU direct payments following the appreciation of the Slovak Koruna. 30. Based on the above assessments of budgetary affordability and support needs of farm incomes but still ensuring a continued increase of direct income support payments to targeted farmers it is recommended that a gradual phasing out CNDP starting 2009 be considered. Such phasing out of CNDPs, which could be impacting the four CNDP at different rates, could still be designed so to ensure increasing support transfers to farmers: A phasing-out of CNDPs by an average of 7.5% of EU-15 annually starting in 33 Kray et al, 2006, based on statistical data provided by RIAFE 68 2009 would be positively overcompensated by the scheduled phasing-in of EU direct income support payments by 10% of EU-15 average. This would induce a 2.5% increase in direct income support payments per year, but would free up about 255 million SKK annually (corresponding to 250% of the current capital spending allocation). In case of Slovakia joining the Euro zone in 2009, the risk of exchange rate-induced reductions in nominal support payments would be eliminated. EU- and Nationally-funded Rural Development Support 31. Since the mid-90s, Slovakia has strongly and successfully focused on rural development support. With the EU accession, even more financial opportunities have become available for Slovakia to translate its multi-year experience into tailor-made programs. 32. As the second pillar of the CAP, rural development is supported by the EAFRD and –for most supported measures– subject to a two-stage counterpart financing by the national budget and project beneficiaries. Slovakia implements this support in the framework of is National Rural Development Program 2007-1334. Support measures included represent Slovakia's choice made from a common, extensive menu of support measures, grouped into four so-called “axesâ€?: Axis 1 supports competitiveness enhancement in agriculture and the food-industry through sectoral (investment) grants. Axis 2 (environment/land management) and Axis 3 (diversification/quality of life) support, to different degrees, the wider territorial (social and environmental) implications of farming. Axis 4 (LEADER) supports implementation of the other three axes through community-based, local development strategies. The choice of measures from these axes has been made based on an analytical section in which the Slovakia identified the development challenges of its rural areas. 33. Slovakia has an appropriately dimensioned rural development program (RDP). The 2007-13 program foresees an EAFRD contribution of 1.97 billion EUR equivalent, with 31.5% being allocated on Axis 1 measures, 50% on Axis 2, 13.5% on Axis 3, and 3% on Axis 4. This distribution is compliant with the minimum axis allocations as mandated by the EC. Slovakia’s obligatory national public counterpart contribution is projected to amount to about 593 million EUR equivalent. Including beneficiary co-financing, the rural development support provided under the second pillar of the CAP is expected to induce an investment (and transfer) volume of about 3.4 billion EUR equivalent. 34 The Rural Development Program 2007-13 (RDP) has been approved by the EC. The detailed manuals for applicants are being prepared and, once approved by the national Monitoring Committee, the RDP will become fully effective. However, payments pertaining to the NRDP have already been made for a limited number of rural development measures (e.g. payments for farming in less-favored areas). 69 Figure 47. CAP Pillar 2 Funds Use in Rural Development, 2007-2013 (‘000 EUR) 0 250 500 750 1,000 1,250 Axis I - Competitiveness Axis II - Agri-environment Axis III - Quality of Life Axis IV - LEADER Technical Assistance EAFRD contribution State budget contribution 34. Sufficient fiscal space has been created to comply with EAFRD counterpart financing obligations. At present, all the matching funds to the in-coming EU rural development resources were made available as needed. Consistent and timely budgetary monitoring and management has allowed for adequate reactions to under- and over- budgeting. Over 2004-06, the respective annual approved budgets were over-sized and had to be scaled down through budgetary corrections. In 2007 insufficient funds were programmed into the approved budget but a later correction helped close the gap. The amounts initially programmed had to be increased by 4.5 times. This adaptation was largely due to the uncertainties with the approval of the RDP for 2007-113. Overall, domestic absorption rates (disbursement-to-adjusted budget ratios) are highly satisfactory and meanwhile range close to 100%. 35. Current medium term budgetary projections (2008-10) are based on conservative scenarios based on fairly constant annual take-up rates, close to the 2007-13 annual average. In fact, as the 2004-06 experience of both Slovakia and other member states shows, new programs have rather slower start-ups. Against this background, the projected 2008-10 funds is considered appropriate. 36. The Slovak RDP is well prioritized and administered. Approximately 65% of the total public expenditure is concentrated in four measures, out of a potential range of about 40. This is one of the highest concentration ratios of the rural development resources across the EU-12. Important administrative cost savings are thus generated. In particular, the sizable less-favored area (LFA) scheme creates a significant leverage effect. The measure, which stands for 25% of the total public support, is simple and 70 effective from an administrative perspective. Payments are made on an area-basis35, similarly with and via the same institutional channels as the Pillar 1 direct payments. 37. Furthermore, an adequate targeting ensures an equitable and regionally- balanced access to resources for farmers. Designed for areas with sub-optimal conditions for farming (e.g. mountainous), the LFA Figure 48. Registered State Aid in EUR/ha, 2008 payments are naturally directed towards the regions of Central 250 and North-Eastern Slovakia. These flows thus offset the 200 regional bias of the investment funds that tend to be 150 predominantly captured by the larger and more efficient farmers in the fertile lowlands 100 in South-Western Slovakia. 50 38. Overall, the RDP so far delivers against expected 0 results. The appropriate sizing SK LT CZ EE PL HU LV SI and prioritization of the program translate into highly satisfactory absorption rates, and prospects remain favorable. Most of the rural development funds allocated during the 2004-06 financial perspective have been committed. At the end of 2007, the commitment rates were higher than 95% for almost all of the rural development measures. With one more year for disbursements to be completed, the payment rates already exceeded 70% for most measures. For 2007-13 the prognosis remains favorable, given that the RDP largely replicates the measures that have been implemented throughout 2004-06. The high share of the LFA scheme in the current financial allocation further facilitates the absorption of the EAFRD funds. The payments have a compensation character and can be easily reached by their targeted beneficiaries. State Aid 39. With the EU member states implementing a common sector policy, the national state aid to domestic agriculture is subject to substantial EU legislative regulation and approval requirements. State aid remains, however, an important policy instrument, particularly in addressing development challenges not covered by the CAP and may justify public intervention (e.g. delivery of certain public goods, support to cultural heritage such a rare horse breeds, or risk and crisis management for events like animal diseases or natural calamities). 35 There scope, however, is different from that of the regular single area payments. They are designed as compensations payments for pursuing farming in mountainous areas or areas affected by various disadvantages (soil erosion etc.). 71 40. The registered State Aid is small when compared to the overall budget size and to neighboring countries. In 2008, it is programmed to reach 368 million SKK, or 1% of the total budget for agriculture and rural development. (see: Figure 46). Slovakia provides the lowest state aid intensities for agriculture among the new member states. 41. State aid measures are highly fragmented and do not build on a coherent objectives- and results-framework. In 2008, the state aid budget is clustered into 13 sub-programs which are then further subdivided. State aid schemes are established on an annual basis and effectiveness would benefit from clearly defined medium or longer term priorities. Support levels show a strong annual volatility. As an example, funding for revitalization of forests and forestry has varied from 5.1 million SKK (2005), to 0.8 million SKK (2006p), and then to 50 million SKK (2008, programmed). Public response to adverse weather conditions has been high in certain years, with the compensations paid taking up as much as 50% of the state aid budget (in 2006). Slovakia continues to be highly exposed in case of crises. No contingency fund was established for 2008, and, if need be, emergency expenditure would primarily be made through the rationalization of other programs. The agricultural State Aid policy is recommended to be revisited to enhance its efficiency. Ideally, such revision would result in clear policy objectives and priorities, as well as in improved targeting and strengthened monitoring and evaluation of the support. 72 Transport Transport Sector Policy Drivers 1. Further integration into the European Union (EU) will require wide ranging reforms and investments in Slovakia, including improvements to the physical infrastructure. The main goals of the government policy, set out in its Manifesto, include promoting a better standard of living in the regions of Slovakia, with the goal of reducing regional disparities36. The quality of road and rail network capacity is limited, the efficiency and safety of infrastructure services are below EU standards, and a large backlog in rehabilitation and maintenance has accumulated mainly due to inadequate funding in the past. Consequently, improvement of transport infrastructure has been included in the Government’s transport program for 2007-2010 and in the Transport Operational Program for 2007-2013. 2. The main objectives of the transport program, as stated by the Ministry of Transport, Posts and Telecommunications (MTPT) are: (a) development of transport infrastructure to enhance efficiency and quality of the transport system; (b) improve accessibility of regions to the trunk transport infrastructure (TEN-T – Transeuropean Transport Network); (c) improve parameters of transport infrastructure to meet EU standards; and (d) improve the quality and safety of the infrastructure to reduce negative effects of transport on environment. Financing Transport Infrastructure 3. In order to accomplish the above objectives, an indicative financial plan has been prepared by MTPT amounting to a total of 7,311 million Euros in the 2007-2013 period, or an average of about 1.2 billion Euros per year. 4. The transport infrastructure investment program includes: (a) Rail: 2,276 million Euros; (b) Motorways (TEN-T): 3,145 million Euros; (c) Expressways and Class 1 roads: 1,594: million Euros; (d) Intermodal terminals: 120 million Euros; and (e) Rail public transport – rolling stocks: 176 million Euros. 5. Sources of funds to support the 2007-2013 transport infrastructure program are planned to be: (a) state budget, 3,158 million Euros; (b) EU funds, 630 million Euros; (c) infrastructure charging, 2,887 million Euros; and (d) public-private partnerships (PPP) in motorways and expressways, 636 million Euros. 6. As reported, the above program is the result of the prioritization of a larger proposed program, taking into account economic efficiency of projects. A challenge for Slovakia is to secure the necessary funding without compromising the country’s overall fiscal and macroeconomic stability. 7. Slovakia is pursuing a balanced modernization approach between roads and railways: the two dominant transport modes carrying more than 90 percent of goods and passengers. This PER chapter on the transport sector focuses on the two modes – Roads and Railways. The Government’s strategy is aimed at promoting productive investments 36 Convergence Program of the Slovak Republic for 2007-2010, 2007 Update, November 2007, page 40. 73 in roads and railways that allow modal competition and enhanced integration with the rest of the EU. 8. The increased level of investments in the transport sector is essential to improve the quality of the country’s infrastructure and bring this closer to EU standards. The required investments are significant, relative to the size of the country’s economy, primarily because of the historic pattern of underinvestment in the past decades, which has resulted in a large investment backlog. The government plans to implement such public sector investments within a well defined medium term expenditure framework (MTEF) so as to maintain macroeconomic stability. 9. The approved budget for transport infrastructure for the 2008-2010 is given in Table 21. Table 21. Approved budget for transport infrastructure (bln SSK) 2007 2008 2009 2010 Total 27.2 30.9 34.6 42.7 Roads 12.9 15.0 13.1 13.2 -maintenance 2.1 2.1 2.2 2.2 -construction 3.2 2.6 2.6 2.6 -motorway construction 7.6 10.3 8.4 8.4 Air transport 0.1 0.1 0.1 0.1 Railways 12.1 11.1 9.9 9.9 -public transport 4.5 5.0 4.5 4.5 -track maintenance 3.6 4.1 3.6 3.6 -track modernization 4.0 2.0 1.8 1.8 Transport policy 2.0 4.7 11.3 19.4 -new EU financed projects (tbd) 0.0 2.7 9.5 17.5 Fees for International Organizations 0.02 0.02 0.02 0.02 Source: Ministry of Transport The roads Sub-Sector Importance of Roads 10. The importance of road transport in the economy is increasing. Road transport is now the primary transport mode in Slovakia. Road transport is increasingly gaining ground at the expense of rail, and has effectively replaced rail transport for short distance, high value, and time sensitive cargo. In 2006, the road market share of freight, in terms of ton-km, was 70 percent. For passenger transport, in terms of pas-km, it was 85 percent. In 2006 there were approximately 307 registered vehicles per 1,000 inhabitants in Slovakia. Car ownership will continue to grow with per capita income, and personal traffic will grow commensurately. As most of the additional demand for transport has been satisfied by road, road infrastructure is already under stress in Slovakia. 74 Road Infrastructure 11. In 2006, there were about 337 km of motorways, 105 km of expressways and 17,837 km of Class I, II and III roads in Slovakia. The international “Eâ€? network includes 11 routes: E 50, E 58, E 65, E 71, E 75, E 77, E 371, E 442, E 571, E 572 and E 575, with a total length of 1,538 km. The Trans European Motorway Network (TEM) includes motorways and roads of total length of 932 km in Slovakia. The Multimodal Corridors Network and corridors of supplementary network (TEN – T) includes roads of total length of 926 km in Slovakia. 12. In addition to motorways and expressways, which are managed by the National Motorway Company (NDS), the public road network includes about 3,080 km of national roads (Class I) directly managed by the Slovak Road Agency (SSC), as well as 14,760 km of Class II and III roads managed by the country’s eight regions. 13. In 2006, about 89 percent of the motorways was in good condition, 9 percent in fair condition, and 2 percent in poor condition, as assessed through pavement roughness in terms of the International Roughness Index (IRI). As for the expressways and Class I roads, 41 percent was in good condition, 33 percent in fair condition, and 26 percent in poor condition. 14. MTPT development priorities include construction and modernization of road infrastructure in routes of multimodal corridors No. IV, V and VI, particularly the construction of motorways and expressways that are part of international transport network TEM and TEN – T. 15. There were 54,968 road crashes in Slovakia in 2006, involving 476 persons killed, 1,629 persons seriously injured and 7,168 persons slightly injured. The most catastrophic crashes involved excessive speeds. Pedestrians were involved in 989 crashes. Financing of Roads 16. As indicated above, the main sources of funds for road infrastructure are the state budget, EU funds, infrastructure charging, and, from 2008, public-private partnerships (PPP) in motorways and expressways. Road user charges applied in Slovakia compare favorably with several other European countries (see Attachment 1 for more details). Fuel excise taxes are the main charge road users pay. Excise taxes on fuel used in the road transport sector were estimated around Euro 882 million in 2006. 17. Fuel excise tax rates in Slovakia, compared with other EU countries, are below average but still higher than in 10 countries (Figure A1 in Attachment 1 provides a comparison using 2004 data). Overall, the rates seem reasonable. 18. A minor distortion, however, seems to occur with the motor vehicle tax (formerly road tax), which is paid by vehicles owned by enterprises, but cars for personal use are exempted. It appears that it would be more equitable to extend such a tax to all vehicles in the country. 19. Slovakia has a vignette system, in line with directive 1999/62/EC, for charging heavy goods vehicles for infrastructure use. The annual proceeds have been about 1.9 billion SKK (58 million Euros). 75 20. As of 2009, an electronic toll collection (ETC) system is expected to replace the vignette system, to be established according to directive 1999/62/EC on charging heavy goods vehicles for infrastructure use, modified by directive 2006/38/EC, and directive 2004/52/ES on interoperability of electronic toll systems in the EU. Annual proceeds of the ETC are expected to be about 9 billion SKK (273 mil. €) in 2013. 21. NDS is managing the bidding procedure to select the ETC operator. There are five pre-qualified bidders, which are expected to submit their bids by the end of March 2008. Vignettes are expected to be replaced by the ETC system by 2009. 22. In view of an ambitious road development program planned by the government for the next several years, there is a risk that expenditure on maintenance and rehabilitation might be displaced in the coming years to finance construction. While the construction of the motorway network is expected to be undertaken as PPPs, future government obligations for the availability payments are estimated at 7 billion SSK per year. Limited Capacity of the Local Construction Industry 23. It is doubtful that the implementing capacity of the road construction industry can handle the proposed increase in road investments. Without careful planning, the proposed program may have a severe impact on construction prices because of the high demand and limited supply. Consequently, the Government will need to create an enabling environment to attract more foreign contractors and further develop the local construction industry. Procurement Practice and Construction Cost 24. There is anecdotal evidence that construction costs, particularly motorways, are higher in Slovakia than in several other EU countries. Carrying out a brief study comparing construction costs (e.g., motorways) in Slovakia and other EU countries would be helpful to identify areas of potential improvements in the contracting and supervision practices in the country. Such a study could build on prior experience, including the EIB database on road construction cost, as well as related analyses, such as a paper by Frédéric Blanc-Brude et al., available on the EIB website at: http://www.eib.org/attachments/efs/efr06n01.pdf 25. There have been recent improvements in contracting procedures in Slovakia. For instance, construction contracts are now awarded only when there is secured funding for paying the contractor). Nevertheless, there seems to be an opportunity to improve procurement practices in particular regarding use of prequalification for larger projects (for example, for motorway construction only post-qualification has been used) and formalizing a policy to deal with price adjustments and variation orders. SSC Operations 26. SSC is responsible for managing about 3,300 km of existing Class I roads, with a staff of 400. A brief review of SSC operations indicates a potential weakness in the way the agency carries out road maintenance. SSC currently carries out maintenance through regional maintenance organizations using non-competitive contracts. Furthermore, payments to such organizations are made based on inputs (i.e., labor, materials, equipment), instead of works actually executed. 76 NDS Operations 27. NDS is responsible for managing about 530 km of existing motorways and expressways, as well as the construction of new motorways and expressways. Its 1,000 strong staff, 70 percent in operations and 30 percent in investment, seems a bit on the high side. NDS could increase efficiency and reduce staff by outsourcing road maintenance. 28. PPP Policy and Institutional Framework. There is no single recipe for successful implementation of PPP program. A PPP framework law is not essential as UK, the European country with the most developed PPP market, has no specific PPP law and relies on its commercial laws for the implementation of PPP projects. Neither is a PPP unit a requirement for success. Spain which has been especially successful in PPP transport projects does not have a central PPP unit. Moreover, several central European countries such as Czech Republic which have enacted both a PPP framework law and established a central PPP unit – but yet have not been able to realize many PPP projects. Figure 49 shows the state of PPP development in Europe and provides insight in the size of the market as well as in the frameworks available for PPP arrangements. Figure 49. European PPP development per country (mln EUR) Source: Infranews and ECORYS PPP Database, October 2007 29. However, Slovakia is unique in that its PPP law is a part of the country’s procurement legislation. PPP is more than a different way of procuring for investments and services. The initiation of a PPP project, the analytic process, its review and approval, the management of fiscal liability, the assessment of contingent risk, the monitoring of ongoing project and the management of the overall PPP program are issues that should be clarified. The Mission was informed that the issue of whether Slovakia needs a PPP framework law will be reviewed shortly. We support this action. 30. PPP Unit. The Mission met with the PPP units at the Ministry of Finance and at the Ministry of Transport. The main task of the MoF-PPP unit is to control the fiscal impact of PPP projects. The nascent MoF - PPP unit’s principal task is to support the line ministries by developing PPP methodological and implementation documents. This unit 77 received €10 million from EU for technical assistance for 6 to 7 projects over a 7 year period. The application of the MoF methodologies are binding on the projects that receive the technical assistance funding and on Ministerial projects (i.e. the large projects). Moreover, for projects over SSK 100 million, the opinion of MoF is needed. The Mission believes the technical assistance support and development of PPP methodologies are essential elements to a successful PPP program. The Mission recommends that MoF provides an initial opinion before the commencement of tendering for large projects with an ex post review and confirmation. Currently, it appears MoF’s opinion is issued after transaction tender and negotiation. Bid preparations for large or technically complex infrastructure projects are very expensive for the private sector. If a tender can be cancelled or the terms of the transaction revised after bid submission and / or after award, it will impact Slovakia’s market reputation. 31. PPIAF Study on Successful PPP Units The World Bank managed PPIAF (Public Private Infrastructure Advisory Facility) recently completed a study on the nature of the contribution made by PPP units to “successfulâ€? PPPs, and which of the many possible functions of such units correlated with successful PPP programs. The study defines a successful PPP program as being one that fosters successive PPP transactions that meet the criteria of: • Providing the services that the government needs; • Offering value for money as measured by the net present value of lifetime costs against traditional public service provision; • Complying with general standards of good governance, transparent and competitive procurement, the government’s legal and regulatory regimes within the relevant sectors and being fiscally prudent. 32. The report recognizes that the creation of a central PPP unit is not a necessary and sufficient condition for successful PPP. The authority of the central PPP unit cannot be derived only from the unit’s statutory position but must be backed up by strong political support and the influence that comes from such support. The report also recognizes that because of the unit’s role in coordinating PPP development, the location of a PPP unit within government will be one of the most important design characteristics. It concludes that PPP units with executive power tend to be more effective than those that are purely advisory, but that this power must be coupled with a mandate to promote and facilitate good PPPs or the unit may simply wield a veto without adding value. For further reference see book and note on “Designing and using Public Private Partnership Units in Infrastructure – lessons from case studies around the world. 33. Fiscal Risk Management for PPP programs The implementation of PPP programs in Slovakia will require consideration of the long-term fiscal implications, both in terms of future liabilities for payment of the service charges (i.e. the availability payments for the Highway PPPs), and in terms of managing other contingent liabilities. The policy will need to set out an approvals process which takes full account of future liabilities through an affordability analysis, and state how the costs of the PPP project are covered. MoF may wish to report future payment liabilities as part of its budgetary process, whether or 78 not these are consolidated into the national debt. They will also want to manage any fiscal risks that arise from contingent liabilities such as those incurred as a result of State guarantees (e.g.. payment to cover unknown geological risks during tunneling). 34. There is not yet a comprehensive fiscal and reporting standard for PPPs. The definition of whether liabilities created under PPP contracts are material or merely contingent is potentially complex, and the internal rules or budgetary controls on borrowing may need to look further at the nature of each PPP contract to determine whether it falls within permitted borrowing, or not. If these controls are too strict or impose financial penalty then this may discourage public bodies from entering PPP projects which may be better value for money than other forms of procurement. On the other hand, MoF will want some oversight of long-term liabilities and other fiscal risks being incurred by public bodies whether or not they fall within the statistical definition used by Eurostat37. However, there are tremendous difficulties in developing appropriate fiscal risk management controls for PPP transactions as illustrated by reference to the UK experience. For reference see “Accounting for PPP Arrangementsâ€?, Financial Reporting Advisory Board, HM Treasury (U.K) December 10, 2007. Box 1. UK’s PPP arrangements The UK government adopted resource accounting to generally accepted accounting principles (UKGAAP) in the 1990s, and when the UK Accounting Standards Board issued its standard on accounting for leases (FRS5) it also issued an Application Note (AN F) which covered PFI (Private Finance Initiatives – what PPP program was formerly called in the U.K) and similar transactions. The Application Note required a qualitative and quantitative analysis of which party to the transaction bore the greater risk as the determinant as to which should recognize the asset on its balance sheet, but stated that demand and residual risks were the clearest indicators of which party should recognize the underlying asset. However, the UK Treasury then issued guidance to the public sector on how to use the Application Note in the form of a Technical Note and each project appointed private sector auditors to give an opinion on whether the transaction should appear on or off the public entity’s balance sheet. For a municipality, only off balance sheet transactions qualified for PFI Credits, additional funding provided by central government to cover the financing costs of borrowing by local government. Central government departments had to cover the full value of any on balance sheet liabilities in its capital budget in the year the asset was brought into service, which was the existing control to discourage departments from entering into finance leases. The result was that on balance sheet PFI transactions were often unaffordable, even if they demonstrated value for money, although around 40% by value of PFI projects in the UK are “on 37 If a PPP transaction complies with ESA 95, the financing obligations are considered by Eurostat as off balance sheet. Eurostat recommends that assets involved in a PPP arrangement should be classified as non- government assets, and therefore recorded off balance sheet for government, if both the following conditions are met : • the private partner bears the construction risks, and • the private partner bears at least one of either availability or demand risk. As a consequence, any contingent liability from a PPP arrangement that meets the above conditions is not account as debt 79 balance sheetâ€? of the public entity that contracted for the service. There has been a difference of view between the public auditors in the UK (primarily the National Audit Office and the Audit Commission) over the interpretation by auditors of the Application and Technical Notes, because they were sometimes leading to neither party recognising assets or they resulted in different opinions for comparable projects. The public auditors requested that Treasury withdraw the Technical Note, although the decision by the UK government to adopt International Accounting Standards means that new application notes will need to be drafted. See: Accounting for PPP Arrangementsâ€?, Financial Reporting Advisory Board, HM Treasury (U.K) December 10, 2007 35. Management of fiscal risk at a policy level by: • Managing calls for additional spending on infrastructure whilst safeguarding fiscal sustainability and the budget process; • Having a clear strategy for investment planning to ensure that high priority infrastructure needs are addressed first; • Have a clear policy on the extent to which innovative financing mechanisms such as PPPs should be pursued; • Having a good institutional framework to provide the necessary checks and approvals on investment decisions; a sound legal and regulatory framework to ensure transparency on contract award, and qualified supervisory institutions; • Clear separation of PPP promotion and PPP oversight functions; • Managing and restricting the guarantees provided. Important guidelines are: *Guarantees may protect only a limited part of the debt, to ensure lenders are still involved in the private party’s performance; *Guarantees can only partially compensate lenders; *Guarantee payments can be conditional on events such as revenue or exchange rate falling below the threshold. 36. Management of fiscal risk at a project level : There should be good procedures for approval of PPP projects. A good system ensures that: • Proposed PPPs by a line ministry / agency must be approved by another government entity before proceeding; • The approving entity has the understanding of the government’s fiscal situation and an interest in maintaining a sustainable fiscal policy; • The approving entity needs to have sufficient information to make a good decision. 37. Slovakia’s PPP program in the Road Sector. The Government is embarking on an ambitious PPP program in the highway sector. Currently there are three packages of motorways and expressways scheduled for tender. They are: 80 • Package 1 Sections on the D1 Motorway from Dubna Skala to Svinia totalling 75 km with an estimated capital cost of SSK 55 billion. (€---). The prequalification has just ended. • Package 2 Sections on the R1 Expressway from Nitra to Tekovske Nemce totaling 47 km with an estimated capital cost of SSK 20 billion (€---). Expressions of Interests are due in early February. • Package 3 Sections on the D1 Motorway from Hricovske Podhradie to Dubna Skala – technically challenging 25 km requiring tunneling and an estimated capital cost of SSK 50 billion. The timing for the tendering is not yet decided. 38. The experience in Europe is that road sector absorbs the most PPP financing at 37% of a €200 billion European PPP market and is often the sector in which the first PPP happens (Figure 50). The Mission supports the Government’s PPP initiative. Based on the country’s fiscal constraints38, its low road network density39 and the past ten years of underinvestment in transport infrastructure40, PPP is a good option. The Mission also supports the availability payment structure for highway PPP and that revenues accruing from electronic tolling flows to the State. The former because it eliminates demand risk for the private sector and thus lowers the project costs41 and the latter because benefits of increased economic activities and traffic volumes will accrue to Slovakia rather than the Highway investors. 39. The Mission recommends that the Government develop a deeper analysis of the range of availability payments that might be required by the private investors to realize these Highway PPP projects. Availability payments are derived not just from a project’s capital costs but also include but not limited to interests during construction, financing costs, equity returns, legal and other transaction costs, operating and maintenance expenses (depends on the maintenance standards for the roads). All-in project costs from which availability payments are derived could be higher than the capital costs by 30% or more. 38 The Government has completed a public sector comparator which is commendable. But when public funding is unavailable to implement a project without private financing, the PSC is largely irrelevant. For example, in Australia, the Fitzgerald report (Fitzgerald 2004) recommended against carrying out the PSC comparison where public sector provision “is not a reasonable option.â€? “Public Private Partnerships in Highways in Transition Economies : Recent Experience and Future Prospectsâ€? Transportation Research Board 86th Annual Meeting (2007) Cesar Queiroz 39 Slovakia has one of the lowest densities of highways in the EU. In terms of highways density of 6.4km/thousand km2 in 2005 – it is ranked 19th place in the EU. The comparable figure in the original 15 EU member states is 17.0 km/thousand km2. 40 The share of transport investments to GDP has been low in Slovakia. It fluctuated from 0.9% of GDP to 1.6% in 2005 – where 2% to 2.5% of GDP would have been reasonable target. During the 2000-2005 period, an average of only 13 km of new highways and expressways were commissioned a year. 41 The private sector will price-in uncertainties related to traffic demand and willingness to pay. 81 40. The Mission, however, strongly advises the Government to reduce the size of the initial Highway PPP packages and to slow down the pace of Figure 50. International Development of PPP per procurement. Slovakia has sector never implemented a PPP Total European PPP market is worth €200 billion transaction. The capital costs of Healthcare Water/ 9% the first two Highway PPP Wastew ater Defence 8% projects mean these are very 15% significant transactions by any Education 7% European standards. The Light Rail announced tendering and 6% negotiation schedules are to be Rail completed by the third quarter 6% Waste of 2008 - extremely fast even if Roads Management 3% these transactions were to occur 37% Accomodation in the U.K. If the Government Other 3% completes these transactions in 7% this timeframe, the country Source: Infranews and ECORYS PPP Database, October 2007 might be with long term agreements with major deficiencies. The more likely scenario is that the tendering and negotiating would be very prolonged - the end result is that this mega tender package approach is no faster (and the terms of the agreement might worse for the country) than if the Government starts the PPP process with a smaller, more manageable project to be followed in quick succession by the rest of Highway PPP tenders. The pre-qualifications for the first PPP package have just been completed with only two qualified bidders. The interested investors have not incurred any real transaction costs and will suffer little economic lost. A revised tender package could qualify more bidders and enhance the competition for Slovakia’s first PPP tender. 41. Recommendations for the road sub-sector: The main recommendations of this report for the roads sub-sector are: (i) Consider the possibility of extending the motor vehicle tax (formerly road tax) to all motor vehicles in the country. This would appear to be more equitable than to exempt cars for personal use. (ii) Carefully review each stage of the ongoing PPP transactions, particularly regarding the future obligations in terms of availability payments. (iii) Further develop the local capacity to carry out PPP projects. (iv) Review the institutional organization of the roads sector (SSC and NDS) in view of making road management and maintenance practice more efficient and more cost-effective. This may include, for instance, modernizing road maintenance through the introduction of performance- based road maintenance contracts with private contractors. 82 (v) Continue the effort to implement an electronic toll collection (ETC) system (which will replace the vignette) on a timely basis for a more sustainable framework for road user charges. (vi) Seek to create a more enabling environment for a more competitive construction industry, which could reduce construction and maintenance costs. This may include the use of prequalification for major road works contracts (only post-qualification is used). (vii) Carry out a brief study comparing construction costs (e.g., motorways) in Slovakia and other EU countries to identify areas of potential improvements in the contracting and supervision practices in the country. Railways Sub-Sector Recent railway reform and achievements 42. In 2001, the Government of Slovakia embarked on a far-reaching reform of the sector along the principles set out in the EU railway directives. With a view to transform the railway into a viable option for providing quality transport services to its users, the reform targeted the following areas: (a) Restructuring and commercialization of railway companies: • Starting from January 1, 2002 the railway infrastructure company, ZSR was separated from the transport services; ZSSK was created as separate company operating freight and passenger railway transport services. • Starting from January 1, 2005 the freight transport services have been separated to a new created company, ZSSK Cargo, and ZSSK remain to operate passenger services. • Railway transport market was liberalized; Public Service Contracts (PSC) and infrastructure access charges were established to put the railway companies at arm’s length from the Government. (b) Labor reduction and operating efficiency: The reform resulted in a 22% staff reduction over the period 2000-2006. It contributed to maintaining the staff productivity in conditions of drastic decrease of the market share. 43. The railway reforms implemented by the Slovak Government followed the related guidelines set by the European Union involving: (i) vertical unbundling of services separating the public railway infrastructure from the operation of railway transport services; (ii) separation of freight from passenger services to establish the conditions of private sector participation in the freight sector; (iii) introduction of track access charges; and (iv) use of Public Service Contracts to frame the Government’s contributions to the sector. 83 44. However, further reforms still need to be implemented to transform the railways into fully commercial enterprises with minimum budget support. The improvements accomplished over the period 2000-2006 have not offset the sharp reduction in traffic volume over the same period, have not substantially reduced the level of Government contributions (the state contribution to railway sector was constantly 0,6% - 0,5% of GDP), nor significantly closed the gap between Slovakian and EU technical and operational railway standards. The railway infrastructure network, service operations and business models, have not yet been sufficiently adjusted to the reduced market demand. Figure 51. Budget support to the Railways (% of GDP) 0.70 0.60 % of GDP 0.50 0.40 0.30 0.20 0.10 0.00 2002 2003 2004 2005 2006 Year Total budget support % of GDP Budget support to ZSSK % of GDP Budget support to ZSR % of GDP Source: Ministry of Transport Operating and financial performance (for detailed information see Attachment 2) 45. Operating performance. Traffic volume (in freight net ton-km and passenger- km) suffered a sharp reduction of 33 percent from 1995 to 2006 due to radical changes in the industrial markets the railways serve as well as in personal mobility. During the same period, freight traffic (in terms of net ton-km) decreased by 29 percent from 13.7 billion to 9.74 because of the decline in the overall transport market. International traffic (import, export, transit) has turned around, while domestic traffic continued to decline. Since 2006, the freight volume of freight traffic has started recovering part of lost traffic. Slovakia has still a railway share of freight around 30 percent (in net ton-km), over twice the EU average. About 86 percent of freight business is generated from international traffic. Freight accounts for about 80 percent of total physical traffic (tons-km and passenger-km) and 85 percent of revenue. Passengers generate 15 percent of revenue. A sharper 48 percent drop (in terms of passenger-km) was registered in passenger traffic with volumes decreasing from 4.2 billion to 2.2 billion because of growing car ownership. The rail share fell to 5 percent in 2006 for passenger transport market (including private cars) from 11 percent in 1995. The effect of the rise in commercial revenues per traffic unit registered from 2000 to 2005 is cancelled by the inflation and the drop in traffic. Hence railway revenues declined in real terms. 84 46. During the interval 2000-2005 the staff productivity was constant around 310,000 traffic units per staff; the continuous traffic drop lowered the efficiency of the staff reduction by about 31%. In 2006 the productivity increased to 350,000 traffic units per staff as a consequence of reducing the staff to about 34,500 and of a slight increase of the freight traffic; however, because of the cumulated drastic traffic drop during the last 10 years, the productivity is still below the level of 1995. Figure 52 shows that the labor productivity of Slovak railways is broadly comparable with most of the CEE railways. However, it is about half of EU-15 average. Labor cost savings have not materialized yet due mainly to increased expenditures for severance pay and corresponding social taxes. Figure 52. Railways Labour Productivity (2006) Traffic Units/Staff 800,000 700,000 600,000 500,000 400,000 300,000 200,000 100,000 0 y y ia p nd ce ly a an ar Re ri ak Ita an la st ng m ov Po Au h Fr er Hu ec Sl G Cz Railway Staff productivity Source: Ministry of Transport 47. The asset utilization by the Slovakian railway system has been increased, but further efforts are necessary to reach the productivity of asset utilization that will make the system competitive on the open railway market in Europe. Presently (see Attachment 3), a passenger car in Slovakia transports in average half of the volumes of passengers realized by the Polish, Austrian, German or Hungarian railways and only one third of the volumes realized by the Italian or French railways. One reason for this situation may be the average age of 24.5 years of the fleet leading to a lower availability and higher maintenance costs. There is a better utilization of locomotive and of the freight cars, but still at the lower limit of competitiveness with other European railways. A better utilization of the locomotives, freight wagons, and passenger cars will decrease the operation costs and will improve the efficiency of Slovak railway system. 48. The Financial Performance. Despite traffic decline, the reform program has put the railways in a better financial position, with most of the financial deficit covered by the State budget support. The overall cost recovery (without subsidy)42 has remained at 76-84 percent in 2001-2005. At the start-up of operation as an independent rail freight operator in 2005, ZSSS Cargo covered its working costs.43 The freight services still provide part of the financial support of passenger service through the medium of track 42 Revenues/operating costs (including depreciation). 43 Excluding depreciation. 85 access charges. The average price paid by freight trains was € 7.6 per train-km, or over five times the price paid by passenger trains despite the greater use of track and the greater demands on track standards and train control systems imposed by passenger trains. The high level of access charges for freight traffic simply reflects inadequate amount of subsidy from the State for operating such infrastructure by ZSR (rail infrastructure manager). Figure 53 illustrates the comparative level of average charges in terms of Euro per train km for EU countries. Along several international corridors in Western Europe, access charges comprise less than 10 percent of operators’ cost. ZSSC Cargo spent 32 percent of its operating costs to cover track access charges. Figure 53. Average Track Access Charges (in € per train-km) 8.0 7.0 6.0 5.0 Euro Freight 4.0 Passenger 3.0 2.0 1.0 0.0 nd ia ry y a en d ce ch d ly K an ki an an an ga rla U Ita an ed ze va m ol om nl un he C w Fr lo er P Fi S H S et R G N Source: Ministry of Transport 49. Revenues from passenger fares covered in 2005 only one third of operating costs because of the low level of standard fares. In 2006, passenger fares were raised by 23 percent in real terms. In addition, there are a high proportion of uneconomic services. ZSSK (passenger rail operator) ended its first year of operation in 2005 as a separate enterprise with a loss of SKK 453 million (€12 million) including the impact of the State compensation totaling SKK 4,850 million (€124 million) mainly for PSO. 50. Since being set up as an independent company in 2002, ZSR (rail infrastructure manager) operating revenue has been steadily declining but covered its operating costs. About 60 percent of its operating costs are covered by track access charges. In 2006, there were 23 railway transport operators including two for passenger services. ZSR relies on the State budget to cover a substantial proportion of infrastructure maintenance and labor costs. Because of partial funding of maintenance and investment by the State budget, Slovak railways relied heavily on debt financing over the past decade. Since early 2007, the State has taken over the debt service of these loans obtained with state guarantee. Total budget support to the railways increased from SKK 5 billion (€116 million, or 0.5 percent of GDP) in 2001 to SKK 8.5 billion (€217 billion, or 0.6 percent of GDP) in 2005. 86 Market responsiveness 51. The railway network, services (in particular for passengers) and business models have not yet been sufficiently adjusted to the reduced demand of the market. With regard to the railway companies’ business models, projects have started helping the railway companies to implement organizational changes based on commercial transactions where marketing and management are essential. ZSSK Cargo is to explore market niches and continue to be pro-active in developing international freight traffic on main corridors. ZSR should define adequate infrastructure maintenance management processes and the organizational structure required to optimize the activities and minimize costs. A solution for the low traffic lines should be implemented according to the commercial principles and taking into consideration the social needs. Since the railway infrastructure operating cost is a sensitive element for all European railways, ZSR must compare its performance with other railway network in order to be competitive and to promote the favorable transit position of Slovakia for international traffic; in this context, the reduction of access charge should be based not only on the financial support of the state, but also on the cost reduction of operation of infrastructure. 52. Key Actions for Further Reforms. The challenge for Slovakia is to ensure interoperability with other EU railways for a railway network of 70 percent over the average network density of Western European railways, but with about the same traffic density, half the labor productivity and with a third of the Gross National Income/capita. The Government’s strategy for the railways sector should aim to achieve the following: (i) The high level of cost recovery in terms of revenues from track access charges as a proportion of total expenditure on the network will lead to the diversion of traffic that could be carried by freight rail onto the road network, with all the associated increases in pollution and congestion. It is necessary to secure lower access charges through productivity improvements and robust cutting measures including network rationalization; (ii) With the emergence of a number of private freight operators and the opening of the market to foreign operators, it is advisable to re-assess the opportunity to privatize ZSSK Cargo; it would inject private skills and capital into the company to face the anticipated growing competition. The privatization of ZSSK Cargo must be carefully prepared, the market value of the company must be increased by implementing adequate restructuring (outsource of non-core activity, commercial approach of all activities, high utilization of assets), the government must ensure a stable business environment by guaranteeing a transparent methodology for calculation of infrastructure access charge, and an independent regulatory body must be in place. (iii) ZSSK Cargo and ZSSK should increase market responsiveness to tailor the services to market demand. ZSSK Cargo must act vigorously for recovering the domestic traffic lost in the last years, and to remain competitive for the operation of international trains. In the context of free transport market in Europe, ZSSK must be prepared to operate international trains (export traffic) up to their final destination, extending its traditional area of activity. 87 (iv) ZSR should focus on implementing an efficiency improvement package to lower its maintenance and investment costs. Continuous comparison with the performance of the neighboring railway infrastructure managers must guide the initiatives of ZSR for increasing its efficiency and responsiveness to the needs of the domestic and international transport market. The implementation of commercial management principles at ZSR is crucial; the infrastructure company must take market oriented decisions, being in competition with other infrastructure managers from the neighboring countries in attracting more international traffic through competitive access charge and high quality services. (v) The contractual relationships between the state and the ZSR, respectively ZSSK for the allocation of public funds for the operation of railway infrastructure and public service obligation for passenger traffic should be further improved introducing measurable objectives allowing the implementation of incentives and penalties for the railway companies. In this way, the state will be able to better control the mode of spending of public funds, the railways companies will become accountable and will receive the funds only based on fulfillment of concrete tasks. Investment program in the railway sector 53. According to the ZSR Strategy the railway infrastructure in Slovakia requires a total volume of investment of approximately 200 billion SK. Three variants are taken into consideration: (i) 7 billion allocated annually will ensure the finalization of the program until 2030, (ii) 12 billion SK allocated annually will finalize the program until 2020, and (iii) 17 billion allocated annually will finalize the program until 2015. The proposed strategy and budget will allow the complete modernization at international standards of about 1/3 of the Slovakian railway network (1200 km), including the international corridors 5,6, and 4, and 4 important railway stations. ZSR prefers the solution of 12 billion allocated every year, but it is highly dependent of the sources from the state budget. During the last two years the rhythm of investment in the railway infrastructure was according to the ZSR proposal The ZSR Strategy may be considered by the government as a sound base for defining the long term strategy for the sector. 54. The government approved in June 2005 the Transport Policy of the Slovak Republic until 2015. It is a good quality document establishing the general and specific objectives of the railway as part of the transport sector. However, it does not contain a full evaluation of the needs of railway system on a longer period of time. The investment program proposed for the Slovakian Railways until 2013 is driven by EU funds and has as main objectives the European objectives of developing the international corridors, ensuring railway inter-operability, and increasing traffic safety. 55. We appreciate that the Slovakian railway system would need a comprehensive assessment of long term needs for creating a reliable system, fully integrated in the European transportation market, taking into consideration not only the European objectives of developing international corridors, but also all internal needs of the country for a sound transport infrastructure. Such an evaluation should be the basis for a long term strategy (20-25 years), defining a vision about the envisaged role of the railway 88 system in the transportation system of the country, developed to answer to the following questions: a) Which will be the transportation needs of Slovakia in the next 20-25 years, taking into consideration the predicted annual growth of GDP and taking into consideration that the worldwide trend is that the transportation needs increase with a higher percentage than the GDP? b) What is the transportation market share targeted for the railway transportation system in Slovakia 20-25 years from now on, taking into consideration the economic criteria and social aspects as climate change, traffic safety, land utilization? c) How much of the predicted transportation volumes in the next 20-25 years could be taken by the existing infrastructure? What additional capacities are necessary and where are they to be developed? d) How to finance the low density traffic lines (2/3 of the network length) not included in the EU funding program? How to prevent the closure of low density lines, necessary for social reasons (East and South of the country, some areas captive to railway transport) or for environmental reasons and tourism (North of the country)? 56. The long term strategy for railway infrastructure should be developed in a harmonized approach with the road infrastructure strategy and should propose variants and priority list of projects to be financed function of the available financial resources. The rhythm of the investments in railway infrastructure must be established function of the needs of Slovakia to reach its objective of development of transport infrastructure as a support for economic development. The EU funds may be sufficient or not for this purpose and alternate solution may be necessary. The allocation of future EU funds and of any other financial resources should be subordinated to the realization of the long term strategy. 57. A very important element in the successful implementation of the ambitious investment program in the railway system in Slovakia is the continuous consolidation of the existing structures at ZSR into a sound and accountable body able to coordinate the elaboration in an accelerated rhythm of the technical documentation of the projects, detailed design and cost estimates, organization of bidding procedures, monitoring of quality of works and keeping the terms of execution and the costs in the contractual limits. Conclusions and Recommendations for Railway Sub-Sector 58. The organization of the railway sector in Slovakia is compliant with the European regulations and is based on commercial principles. A bold restructuring strategy was implemented, but the reform program must continue in an accelerated rhythm for the consolidation of the new created companies and the elimination of the existing constrains. 89 59. If the Government is to hold back the sector’s burden on the State budget without impeding the sound financial management of the railway companies, the sector strategy should be translated into the following practical steps: a) Correction of the legal and institutional framework must be defined and implemented to consolidate a fair business environment on the railway transportation market in Slovakia b) The sector reform must continue in order to transform the railway into a reliable option on the transportation market for higher quality services c) Improvement of the contractual relationships between the state and ZSR, respectively ZSSK is necessary for increasing the accountability of the railway system for the utilization of the public funds d) A long term strategy regarding the investment in the railway sector must be developed in a harmonized approach with the road sector for solving the needs of economic development and social needs of Slovakia 60. The correction of the legal and institutional framework for consolidating a fair business environment in the railway sector should contain the following main actions: a) The development of a new methodology for the calculation of the infrastructure access charge in accordance with the EU regulations. In this way, each railway operator (freight or passengers) will pay the marginal cost generated by the usage of railway infrastructure. It will stop the actual over charging of ZSSK Cargo with high risks in medium term for the transport market in Slovakia: cross- subsidy of railway passenger transport will induce the artificial increase of freight tariffs, decrease of the freight railway market in favor of other modes of transport, and exclusion of Slovakia from the European railway transit routes. b) The state must analyze and progressively implement a non-biased financial contribution for supporting and developing the road and railway infrastructure, taking into consideration the economic objectives and social needs and avoiding the distortion of the transportation market. c) The state should support the restructuring of ZSSK Cargo in order to become a more attractive company for privatization, should guarantee the transparency and stability of infrastructure access charge for allowing the development of medium term business plans, and should estimate the most appropriate moment for the privatization of ZSSK Cargo. The main scope of privatization will be to consolidate the chances of ZSSK Cargo to become a strong international operator on the European transportation market 61. The continuation of the reform of the railway sector must include the following: 90 a) ZSSK and ZSSK Cargo will develop concrete annual programs for increasing the efficiency of utilization of assets (wagons and locomotives) for reducing operation costs. b) All railway companies will act for outsourcing by privatization all non-core activities affecting the efficiency of their main business c) All railway companies will continue to act for the increase of the staff productivity in order to become more competitive in comparison with the neighboring railways d) ZSR will act for solving the problem of low density traffic lines affecting their operational costs, but not generating sufficient income. Each line should be analyzed together with the parties interested in maintaining the line open and a concrete solution must be defined taking into consideration the economic principles and the social needs (financial contribution of entities interested in maintaining the line open or closure of line) 62. The improvement of the contractual relationships of the state with the railway infrastructure manager (ZSR) and the railway passenger transport operator (ZSSK) should be based on: a) Definition of measurable objectives and responsibilities for the railway companies for allowing the control of fulfillment of contractual obligations b) Increasing the accountability of railway companies by introducing in the contracts of penalties for failure to reach an objective or for partial realization of it. The public funds for railway infrastructure and for passenger services should not be allocated unconditionally, but function of realization of the contractual obligations. . 63. The elaboration of the long term strategy for the development of the railway sector should be based on the following principles: a) The strategy must be developed for a period of 20-25 years and must be harmonized with the strategy for the road transportation system b) The strategy must be based on the needs of Slovakia for developing a sound transport infrastructure, capable to sustain the economic development of the country and to solve the social aspects c) The state must support the modernization of the rolling stock for the passenger traffic, taking into consideration the social role of this service and the necessity to offer a chance to ZSSK in the perspective of the liberalization of the passenger international transport market. 91 Attachment 1 A Comparison of Road User Charges (RUC) in Slovakia and Selected European Countries It is in the interest of the road users to have well maintained roads, as the operating costs of their vehicles are reduced substantially more than the corresponding cost of road maintenance. The principles of taxing road users are that charges should be economically efficient, equitable, cost little to collect and are not easily evaded. Data currently available for 15 European countries, including Slovakia, are summarized in Table A1. As indicated in Table A1, the taxes related to road use charged in Slovakia are compatible to other European countries. In relative terms, as shown in Table A2, road users in Slovakia pay more than several of their European counterparts. For example, road users in Slovakia pay annually an amount corresponding to 262% of national road expenditures, which is higher than in eight of the 15 countries, included in the survey; the average amount paid annually per vehicle, at Euro 683, is higher than in six of the 14 countries for which data was available. Fuel excise taxes in Slovakia, compared with other EU countries, are below average but still higher than in 10 countries (Figure A1 provides a comparison using 2004 data). Overall, the rates seem reasonable. A minor distortion, however, seems to occur with the motor vehicle tax (formerly road tax), which is paid by vehicles owned by enterprises, but cars for personal use are exempted. It appears that it would be more equitable to extend such a tax to all vehicles in the country. Suggestion: Consider extending the motor vehicle tax to all motor vehicles in the country. Table A1. Summary results of a brief survey of road user charges in selected European countries National road Length of Vehicle Other road use Total road user Total road expenditures (mln national roads Total road Total fuel tax Vignettes (mln registration fees related taxes charges (mln expenditures (mln Country EUR) (km) network (km) (mln EUR) Toll collection EUR) (mln EUR) (mln EUR) EUR) EUR) Latvia 195 20167 69675 314 0 n.a. n.a. 195 509 240 Hungary 449 31067 187800 1848 n.a. 108 n.a. 341 2297 n.a. Finland 840 78189 430000 2946 0 n.a. n.a. n.a. 2946 n.a. Slovenia 736 6301 33562 n.a. 158 n.a. n.a. 593 751 n.a. Sweden n.a. 103000 572000 2800 n.a. n.a. n.a. n.a. 2800 1850 Lithuania 295 21328 80509 377 0 11 11 1 102532 373 Italy 2900 30128 80477 36200 5394 n.a. n.a. n.a. 41594 n.a. Germany 6120 55000 231581 40000 1080 n.a. n.a. n.a. 41080 n.a. Switzerland n.a. 1800 70000 3000 n.a. n.a. n.a. n.a. 3000 4500 United Kingdom 9000 41972 417000 37000 306 n.a. 7300 n.a. 44606 n.a. France 5100 20000 n.a. 26000 6600 n.a. 2200 2000 36800 n.a. Norway 2230 27000 93000 1200 520 n.a. n.a. n.a. 1720 2600 Austria 1500 2080 n.a. n.a. 935 300 n.a. n.a. 1235 n.a. Poland 2200 18000 360000 4368 49 145 n.a. 1450 6012 n.a. Slovakia 388 3521 18278 882 0 51 0 83 1016 n.a. 92 Table A2. Comparison of road user charges in selected EU countries User Total Total road Stock of charges per National road Length of fuel tax user User charges % of motor vehicle expenditures national (mln charges national road vehicles (EUR) in Country (mln EUR) roads (km) EUR) (mln EUR) expenditures (000) 2006 Latvia 195 20167 314 509 261.0 866 588 Hungary 449 31067 1848 2297 511.6 3334 689 Finland 840 78189 2946 2946 350.7 2805 1050 Slovenia 736 6301 n.a. 751 102.0 1016 739 Sweden n.a. 103000 2800 2800 n.a. 4628 605 Lithuania 295 21328 377 400 135.6 1593 251 Italy 2900 30128 36200 41594 1434.3 38942 1068 Germany 6120 55000 40000 41080 671.2 48939 839 Switzerland n.a. 1800 3000 3000 n.a. n.a n.a United Kingdom 9000 41972 37000 44606 495.6 31886 1399 France 5100 20000 26000 34800 682.4 36702 948 Norway 2230 27000 1200 1720 77.1 2523 682 Austria 1500 2080 n.a. 1235 82.3 4949 250 Poland 2200 18000 4368 4562 207.4 14723 310 Slovakia 388 3521 882 1016 261.9 1487 683 Note: Although 15 countries were surveyed, not all data is available for each country Figure A1: Fuel excise taxes in EU25, 2004 Data 900 800 Leaded Unleaded 700 Gas Oil Minimum Leaded 600 Minimum Unleaded Minimum Gas Oil Euro/1,000 liters 500 400 300 200 100 0 UK NL DE FR FI BE IT PT DK IE SE HU LU AT ES SI SK PL CZ MT EL CY LV EE LT RO BG 93 Attachment 2 Indicators of Railway Operating and Financial Performance 1995 2000 2004 2005 2006 Traffic units (billions) Passenger km 4.2 2.9 2.2 2.2 2.2 Freight ton km 13.7 11.2 9.7 9.3 9.7 Total traffic units 17.9 14.1 11.9 11.5 11.9 2001 2002 2003 2004 2005 Inflation (%) 7% 3% 9% 8% 3% SKK per USD (period average) 48 45 37 32 31 SKK per EUR (period average) 43 43 41 40 39 Yield - Commercial traffic revenue per traffic unit Passenger (receipt per passenger km) in SKK 0.79 0.81 0.94 0.98 1.24 Passenger (receipt per passenger km) in EUR 0.02 0.02 0.02 0.02 0.03 Real change in % (SKK) 0% 7% -4% 23% Freight (receipts per ton km) in SKK 1.28 1.43 1.44 1.53 1.74 Freight (receipts per ton km) in EUR 0.03 0.03 0.03 0.04 0.05 Real change in % (SKK) 8% -7% -1% 11% Overall Yield (SKK) 2.07 2.24 2.38 2.50 2.97 Real change in % (SKK) 5% -2% -2% 16% Staff 2001 2002 2003 2004 2005 Total railway staff - year end 44,595 43,688 41,627 39,151 36,689 Change in % -2% -5% -6% -6% Productivity (thousand of traffic unit per staff) 308 299 299 304 313 Change in % -3% 0% 2% 3% Labor cost per employee (EUR) 5,557 6,114 6,630 7,577 8,272 Change in % 10% 8% 14% 9% Operating costs 2001 2002 2003 2004 2005 Unit operating costs, excluding track access charges (SKK) 1.9 2.1 2.3 2.4 2.6 Real change in % (SKK) 5% 0% -3% 6% Track access charges for passengers (EUR/pkm) 1.2 1.3 1.4 1.4 Track access charges for freight (EUR/net tkm) 7.2 7.4 7.5 7.6 Operating costs structure (% of total operating costs) 2001 2002 2003 2004 2005 Total labor cost 41% 32% 32% 34% 32% Maintenance, overhauls, and materials 22% 16% 15% 11% 14% Track access charges n.a 23% 21% 20% 19% Cost recovery 2001 2002 2003 2004 2005 Cost recovery (1) (without subsidy) 76% 84% 80% 75% 76% Cost recovery (1) (with subsidy) 95% 99% 123% 94% 99% 2001 2002 2003 2004 2005 State subsidy as % of GDP 0.5% 0.5% 1.3% 0.5% 0.6% Working Ratio without subsidy (2) 2001 2002 2003 2004 2005 ZSR 100% ZSSK CARGO 98% ZSSK 268% Working Ratio with subsidy (3) ZSR 71% ZSSK CARGO 98% ZSSK 96% (1) Revenues/Operating costs (incl depreciation) (2) Operating costs (excluding depreciation)/operating revenues (without subsidy) (3) Operating costs (excluding depreciation)/operating revenues (with subsidy) 94 Attachment 3 PRODUCTIVITY OF RAILWAY ASSETS UTILIZATION Traffic Units/Staff 800,000 700,000 600,000 500,000 400,000 300,000 200,000 100,000 0 y ia y p nd ce ly a an ar Re ri ak Ita an la st ng m ov Po Au h Fr er Hu ec Sl G Cz Railway Staff productivity Traffic Units/Loc./Day 100,000 80,000 60,000 40,000 20,000 0 y ia y p nd ce ly a an ar Re ri ak Ita an la st ng m ov Po Au h Fr er Hu ec Sl G Cz Railway Locomotive Productivity Tonnes-km/Wagon/Day 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 y ia y nd ce p ly a an ar Re ri ak Ita an la st ng m ov Po Au h Fr er Hu ec Sl G Cz Railway Freight Wagon Productivity/Day 95