Report No. 25990 FOR OFFICIAL USE ONLY KOSOVO Labor Market Study: Policy Challenges of Formal and Informal Employment June 26, 2003 Hum an Devel opment Unit Europe and Central Asia Region Document of the World Bank - ii - Currency Equivalents Currency Unit = EUR €1 = US$0.9875 (as of October 1, 2002) Government Fiscal Year January 1-December 31 Wei ghts and Measures Metric Sys tem Abbreviations and Acronyms DM Deutsch Mark GDP Gross Domestic Product ILO International Labour Organization KFOR Kosovo Force LFS Labor Force Survey LM labor market LSMS Living Standards Measurement Survey MLSW Ministry of Labor and Social Welfare OEC D Organization for Economic Cooperation and Development PISG Provisional Institutions of Self Government SOK Statistical Office of Kosovo SRSG Special R epresentative of t he UN Secretary General SFRY Socialist Republic of Yugoslavia UNMIK United Nations Interim Mission in Kosovo Vi ce Presi den:t J ohannes F. Li nn (ECAVP) Country Director: Orsalia Kalantzopoulos (ECCU4) Sector Director: Annette Dixon (ECSHD) Sector Manager: Michal Rutkowski (ECSHD) T eam Leader: J eanine B raithwaite (ECSHD) - iii - Acknowledgements Speci al thanks to the Statistical Office o f Kosovo (SOK) and Ronnie Andersson for acces s to the l abor force survey (LFS) dat a and t o the Minis try of Labour and Social Welfare for data on the registered unemployed. All results for the LFS data for 2002 are highly preliminary, and are the result of World Bank calculations, they are not o fficial data from SOK. T he survey on t he informal labor market and accompanying qualit ative studi es were done by Prism Research of Kosovo and B osnia. The World B ank is grateful to Riinvest for data and invitation to the Riinvest conference on the labor market in Kosovo. Thanks to peer reviewers Gordon Bechterman, Philip O’Keefe, and Alexandre Kolev, as well as to R onnie Andersson, Jose Assalino, Edward Funkhouser, Mike Ives, and Janusz Szyrmer for useful discussions and comments. Other World Bank comments are gratefully acknowledged from Orsalia Kalantzopolous, Michal Rutkowski, Marina Wes, Tracey Lane, T imot hy Gi lbo, and Pierell a Paci. The team comprised Jeanine Braithwaite (Team Leader, ECSHD), Milan Vodopivec, (HDNSP), Ian Conachy, Anna Goodman, Anahit Poghosyan (ECSHD), Hjalte Sederlof and Jakob Tomse (C onsulta nt s). Readers interested i n offici al statisti cs for Kosovo should visi t the SOK websit e: http://www.sok-kosovo.org/ World Bank public documents on Kosovo can be found at: http://worldbank.org/ - iv - Executive Summary Employment is a major challenge for policy m akers in K osovo, and the creation of well-paying jobs is a major policy objective. This study examines the labor market side of this policy objective, seeking to understand and analyze the labor market and the sources of empl oyment, both formal and informal. Ultimately, the success ful creati on o f plenti ful and well- remunerated employment opportunities resides in policies that would ignite economic growth in Kosovo, including macroeconomic stability and rightsizing the public sector. Kosovo’s labor market policies are generally right on track for the flexibility that characteri zes well-functioning labor markets in market economi es. In particular, the low level of payroll taxes is extremely important in keeping the cost of labor down and providing an incentive to employers to employ more labor. Labor-intensive growth is Kosovo’s objective for economic development, and keeping the cost of labor highly competitive in the region is a key ingredient to achieving this objective. In Kosovo, it appears that any kind of economic activity (informal or formal) is a bulwark against poverty and that marginall y-subsistent acti viti es are not as widespread (or else are severely under-reported because respondents don’t consider them to be “ real work” and owing to stigma). People in Kosovo think of “work” as essentially only formal employment. Working in the informal sector or in a family business or on a garden plot of land are not considered by respondents to be “ work” even though they obtain income from these activities. However, since the income is irregular and unpredictable and is not a formal paycheck, people do not consider themselves to be “working” even though they should be counted as employed in standard labor market analysis. These perceptions of what constitutes “ real work” in Kosovo are very important for interpreting the results of household and individual surveys, particularly those that are used to m easure unemployment rates. This report concludes that the “most likely” unemployment rate in Kosovo is 23-33 percent of the labor force, although the formal labor market is analyzed based on the adjusted LFS data that put unemployment at around 40 percent in 2001. Macroeconomic Overview Kosovo w as tradi tionally the poorest part of the former Socialist Republic of Yugoslavia (SFR Y). In 1988—the last full year of autonomy under the SFRY constitution— recorded output per head was 28 percent o f t he SFRY average. Over the succeedi ng six years, GDP contracted by 50 percent, falling to less than US$400 per head by 1995, according t o o ffi cial st atistics. Economic growth has been significant, driven by reconstruction spending, private transfers from Kosovars living abroad, and the presence of a large number of expatri ates in Kosovo. Estimates suggest that GDP in 2002 was equivalent to around $900-$1000 per capita. Following double-digit growth rates in 2000, estimates show that real GDP growth has fallen somewhat in 2001 and 2002. Indicators of disposable income and consumption suggest an even - v - stronger recovery of aggregate demand since 1999. In 2002, consumption and investment combined were almost twice as high as 2002 GDP, reflecting the magnitude of foreign assi stance, largely spent on imports. Furthermore, with remitt ances over the past three years estimated at some 25-30 percent of GDP annually, national income is significantly higher than GDP. Due to massive offi cial and pri vate transfers, imports of goods and non-factor services are estimated to have reached around 100 percent of GDP in 2002, albeit down from 150 percent in 2000. Formal Labor Market Analysis The Kosovo population is one of the youngest in E urope and the rate of natural increase of population is believed to be one of the highest in Europe. One-third of the population is under 15, about half of it under 24, and only about 6 percent of the population is older than 65. Despite difficult postw ar conditions and abnorm al circumstances duri ng most of the 1990s, Kosovo’s labor market is on its way to functioning normally. Stimulat ed by institutional flexibility and liberal wage determination framework, employment has rebounded to prewar levels, but unemployment rate is still large, particularly at its seasonal peak. Further expansion of employment has been prevented by both insufficient labor demand, partly caused by the war destruction of production capacities, and by skills mismatch – the fact that labor for ce participants, many of whom are unskilled, do not possess the skills needed in a market economy. The institutional void created by unusual postwar circumstances provides a unique opportunity to steer the development of labor market legislation and institutions (among others, the labor code, coll ecti ve bargaini ng, and income support s ystem) so as to promote flexibil ity, job creat ion, and equitable labor market outcomes. Labor force and em pl oym ent participation has been low, and unempl oym ent high. In November 2002, labor force participation rate in Kosovo was 41.3 percent, with male participation rate at 56 percent and women participation rate at only 27 percent, which are the lowest rates in the Balkan region. Although Kosovo’s postwar employment quickly rebounded to a historically high level, employment rate in 2002 was a low 43 percent in urban and 30 percent in rural areas. And reflecting di fficult labor market situation, postwar unemployment rates have been quite high – as high as 41 and 47 percent in 2001 and 2002, respectively. Because the two last official labor force surveys both took place in winter and thus measure employment at its seasonal low and unemployment at its peak, no reliable estimates exist about the non-seasonal employment and unemployment rates. Labor force participation rates are particularly low for young workers and women, even more so in urban areas. Liberal wage determination system has promoted labor mobility and employability. In contrast to some successor countries of Yugoslavia (for example, Bosnia and Herzegovina and Slovenia), Kosovo’s liberal, flexible wage determination system has spurred labor mobility and employability, and produced only a small wage gap between men and women. Moreover, labor demand has been stimulated by small tax wedge on the use of labor, which has helped keeping a non-segmented labor market. For example, those under oral contract faced l itt le reduction in their wages in comparison with those with written contracts. However, non-competitive product - vi - markets (such as the one in the financial sector) contributed to above-normal wages in some sect ors. Ethnic minorities have f aced ex ceptional labor market difficulties. Econometric results show that the members of Kosovo’s ethnic minorities have faced higher probability of being unemployed, and have been paid less, than Albanians with similar characteristics. Kosovo’s l abor force possesses outdated s kill s w hich are only modestly rewarded in the market economy. It seems that the weak labor force attachment in the 1990s of many older workers degraded thei r skil ls, and t hat the parallel education syst em reduced labor market performance o f the recent generations o f school-leavers.