Romania - The challenge of transition (Vol. 1 of 2) : Volume one

Report No. 9497-RO Romania The Challenge of Transition (In Two Volumes) Volume I December 3, 1991 Country Department I Europe and Soviet Union Region FOR OFFICIAL USE ONLY 41 Document of th Wod1d Baik This doument has a restrictqd distribution~ and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. 0  CURRENCY EQUIVALENTS Unit of Currency: Leu (Plural: Lei) Exchange Rate: Lei per U.S. Dollar Period Average End of Period Lei/Trans. Period Commercial Non-Commercial Commercial Non-Commercial Ruble 1975 20.000 12.000 20.000 12.000 n.a 1980 18.000 12.000 18.000 12.000 n.a. 1985 17.141 12.241 15.730 11.230 15.5 1986 16.153 11.337 15.280 10.500 15.5 1987 14.557 9.759 13.740 8.420 15.5 1988 14.277 8.747 14.370 8.840 15.5 1989 14.922 8.992 14.490 8.910 15.5 1990 22.432 ... 34.710 ... 17.0 1991 March n.a. ... 36.97 April n.a. ... 60.67 Source: IFS: 1983, 1984 and 1991; Romanian authorities. Note: The commercial rate applies to all foreign trade and capital transactions in convertible currencies, and a non-conmnercial rate applied largely to tourism. The Transferable Ruble rate was abolished in February 1991.  FOR OFFICIAL USE ONLY GLOSSARY OF ABBREVIATIONS BAFI Bank of Agriculture and Food Industry BA Bank Agricola BIS Bank for International Settlements CEC Savings Bank CBR Crude Birth Rate CMEA Council for Mutual Economic Assistance EEC European Economic Community FJAS Foreign Information Advisory Service FTO Foreign Trade Organization GAAP Generally Accepted Accounting Principles GDR German Democratic Republic GOR Government of Romania GW Giga-Watt HA Hectares IBEC Intemational Bank for Economic Cooperation ICOR Incremental Capital Output Ratio MAFI Ministry of Agriculture and Food Industry MNE Ministry of the National Economy MOE Ministry of the Environment MOF Ministry of Finance MOLSS Ministry of Labor and Social Services MPWT Ministry of Public Works and Transport MW Mega-Watts NAP National Agency for Privatization NBR National Bank of Romania NEM New Economic Measures POF Private Ownership Fund QR Quantitative Restrictions RA R6gie Autonomae RBD Romanian Development Bank RBFT Romaian Bank for Foreign Trade RCB Romanian Contxercial Bank SME Small- and Medium-Scale Enterprises SOE State-owned Enterprise SOP State Ownership Fund TOE Ton Oil Equivalent TR Tansferable Ruble VAT Value Added Tax This document has a restricted distribution and may be used by recipients only in the performance of their offcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  iii COUNTRY DATA - RQMANIA GNP per capita in US$ in 1990 1,640 General Area (sq. knm) 238,000 Population (th), 1988 23,150 Growvl rate (%) 0.5 Density (per sq. km) 97 Social indicators Population characteristics Birth rate (per 000 inhabitants) 16 Crude death rate 10.6 Health Infant mortality rate 23.8 Population per physicial 657 Populatior per hospital bed 114 Income distribution (% of national income) Highest quintile NA Lowest quintile NA Distribution of land ownership % owned by top 10% of owners NA % owned by smallest 10% of owners NA Access to safe water % of urban population NA % of rural population NA Nutrition Calories per day NA Per capita calorie intake (gr. per day) NA Education Primary school enrollment (% of relevant age group) 97 Secondary school enrollment 79 Colleges, universities, specialized .chools NA GROSS DOMESTIC PRODUCr AT CURRENT PRICES (Lei billon) Current Prices Real Growth Rates azin.~ ~ ~ ~ ~~~~~( Lei M a.) 1980 1985 1990 1985 1987 1989 1990 Gm at Marke PEs 616.9 817.4 844.0 *0.1 0.8 -5.8 -7.4 Consumption 388.4 491.9 652.9 -0.7 3A 1A 9. Investment (total fixed) 212.8 246.3 168.4 1.7 -1.4 -1.6 -383 Change in stocks 32.9 23.6 120.9 -30.2 -38.3 .648A -211.6  iv OUTPUT, EMPLOYMENT, AND PRODUCrIVITY GDP in 1990 Employment in 1990 GDP per worker lei bin % of total thousands % of total Lei % of average Agriculture 152.0 18.0 3,001.0 27.0 50,649.0 66.6 Industry 407.0 48.2 4,203.0 37.8 96,935.6 127.4 Other 285.0 33.8 3,902.0 35.1 73,039.0 96.1 Total average 844.0 100.0 11,106.0 100.0 75,995.0 GOVERNMENT FINANCE Consolidated general government Lei bin % of GDP 1990 1990 1985 Total revenue 341.0 40.4 48.9 Total expenditure 331.1 39.2 46.0 Overall balance 9.9 1.2 2.9 Current expenditure 2653 31.4 19.2 Capital expenditure 65.8 7.8 17.6 MONEY, CREDIT, AND PRICES 1987 1988 1989 1990 Money supply aj 378.2 424.8 441.7 520.7 Net credit to government -245.8 -283.0 -234.4 -2.7 Credit to non-government 773.6 813.1 810.4 684.0 Money supply/GDP 44.8 49.6 55.4 61.7 Inflation rate 0.5 2.9 0.6 5.1 a/ Broad money  v MERCHANDISE EXPORTS (1990) To all countries Value mln. TJS$ % of Total Foodstuffs 66.0 1.1 Fuel and metals 1,978.0 33.7 Machinery and equipment 1,809.0 30.8 Other raw materials 392.0 6.7 Chemicals 380.0 6.5 Industrial consumer goods 1,245.0 21.2 Dollar trade total 5,870.0 100.0 EXCHANGE RATE Annual Average 1987 1988 1989 1990 1 Leu - US$ 14.6 14.3 14.9 22.4 1 US$ - Leu 0.07 0.07 0.07 0.04  vi BALANCE OF PAYMENTS IN CONVERTIBLE CURRENCIES (In US$ million) 1980 1985 1986 1987 1988 1989 1990 1. Current Account -2,399 1,108 1,528 2,225 3,625 2,825 -1,650 Merchandise exports fob 6,503 6,1>.. 5,127 5,864 6,511 5,965 3,364 Merchandise imports fob 8.037 4,598 3,238 3,428 2,903 3,406 5,107 Services net -865 -450 -361 -211 17 305 93 Receipts NA 616 568 703 758 731 681 Payments NA 1,066 929 914 741 426 588 Non-interest current account -2,399 1,760 2,137 2,652 3,880 2,850 -1,787 Interest, net 0 -652 -609 -427 -255 14 137 Transfers, net 0 0 0 0 0 0 107 Receip;i 0 0 0 0 0 0 131 Payments 0 0 0 0 0 0 24 2. Capital Account 2,154 -1,298 -817 -1,155 -3,818 *1,540 47 M & LT loans drawn, net 1,810 -978 -880 -1,453 -3,388 -1,620 33 Disbursement 2,851 291 541 136 52 26 33 Amortization 1,041 1,269 1,421 1,589 3,440 1,646 Loans extended, net NA -214 -121 -101 -228 -83 47 Disbursement NA 63 235 326 121 94 88 Amortization NA 277 356 427 349 177 41 Short-term loans, net 344 -106 184 399 -202 163 -15 Direct investments, net 0 0 0 0 0 0 -18 3. Errors and Omissions NA -127 -98 -29 -92 30 -43 Overall Balance -245 -317 613 1,041 -285 1,354 -1,646 Financing 245 317 -613 -1,041 285 -1,354 1,646 Reserves, end of period NA 345 721 1,470 848 1,959 330 Change in reser. (-inc.) 212 492 -376 -749 622 -1,111 1,629 Source: National Bank of Romania  vii BAIANCE OF PAYMENTS IN TRANSFERABLE ROUBLES (in USS millon) 1980 1985 1986 1987 1988 1989 1990 1. Current Account -21 227 -160 -68 332 -290 -1,452 Exports of goods, fob 4,521 3,384 4,012 4,206 4,450 4,144 2,170 Import of goods, fob 4,648 3,208 4,238 4,349 4,271 4,602 3,678 Services, net 106 51 66 75 153 168 56 Receipts 194 200 187 254 273 241 Payments 143 134 112 101 105 185 Non-interest curr. account NA 194 -204 -78 292 -344 -1,472 Interest, net NA 33 44 10 40 54 20 Transfers, net 0 0 0 0 0 0 -1 Receipts 0 0 0 0 0 0 7 Paynments 0 0 0 0 0 0 8 2. Capital Account 68 -73 -68 49 -59 .37 1,027 M & LTloans drawn, net 0 0 0 0 0 0 Disbursement 0 0 0 0 0 0 Amortization 0 0 0 0 0 0 Loans extended, net -73 -68 49 -59 -37 -24 Disburscment 96 103 56 35 55 133 Amortization 169 171 105 94 92 157 Short-term capital, net NA 0 0 0 0 0 1,051 3. Errors and Omissions NA 16 110 112 107 183 34 Overwp Fiaiaae 47 170 -118 -5 380 -144 -391 Source: National Bank of Romania  ix VOLUMEI TABLE OF CONTENTS EXECUTIVE SUMMARY .................... i-xviii CHAPTER 1: ECONOMIC STRUCTURE AND DEVELOPMENTS .1 I. Introduction . II. The Centrally Planned Economic System .2 111. Demography and Social Developments ...................... ... 4 A. Population Deve':---wnts ......................... 4 B. Social Indicators ......................... 5 C. Health ......................... 7 D. Education ....... ..... 7 E. The Social Benefits System ..... 8 IV. The Macroeconomy ........................ 10 A. Growth ................................... 12 B. Domestic lnvestment and Consumption ......................... 13 C. Public Finance ................................... 17 D. Money and the Financial Sector . ............................ 19 B. Exteral Trade and Payments ................................ 22 P. Employment, Labor Markets, Wages, and the Distribution of Income ................................. 32 V. Macroeconomic Stabilization ..32 A. Introduction .32 B. Prices and Wages .35 C. Fiscal Policy .38 D. Moneary and Credit Policy ...... .............. ........... 41 E. Stabilizing External Accounts ................... ............ 41 CHAPTER 2: SECTORAL DEVELOPMENTS ...... .......................... 45 I. Industry .............................. 4 A. Strategy and Structure ................................... 45 B. Growth, Employment and Productivity ......... ................ so C. Investment .................................... S1 D. Trade .................................... 52 B. Prices and Competitiveness ......53............... 53 F. Profits, Losses, and Subsidies ...................... 55 II. TheEnergySector ........................ 56 M. Agricuture .......................... 65 IV. afatrcture .......................... 73 V. Housing .......................... 76  Page No. CHAPTER 3: SYSTEMIC REFORM AND MANAGEMENT ISSUE:S .... ........ 79 I. Introduction .79 11. Liberalization, Stabilization, and Economic Management .81 A. Price Liberalization .83 B. Wages, Employment, and the Social Safety Net .................... 88 C. Fiscal Policies and niscal Reform ......... ................... 93 D. Monetary Policy and Financial Sector Reform ...... ............... 99 E. Exchange and Trade Reform ........... ................... 104 F. Debt Strategy ....................................... 107 G. Rationalization of Public Investment ........ .................. 108 III. Reforming the Business Environment, Property Rights, Competition and Restructuring ............ ............... 115 A. Privatization of Property ......... ........................ 115 B. Agricultural Land Ownership .............................. 116 C. Urban Land and House Ownership ........................... 116 D. Privatization and Enterprises .............................. 117 E. Private Enterprise and Competition Policy ...................... 122 F. Governance and Restructuring of Public Enterprises .... ............ 125 0. Proposed Approach to Restructuring .......................... 126 H. The Role of the State .......... ......................... 130 CHAPTER 4: SECTORAL ADJUSTMENT ............................ 131 I. Introduction ..131 II. The Industrial Sector ..132 A. Subsectoral Adjustments . 132 B. Electronics, Electrotechnics and Fine Mechanics (EE) .136 C. Textiles, Garments, Footwear and Leather (TGFL) .137 D. Investment Policy .138 E. Technology Modernization .138 F. Export Promotion and Marketing .139 IIE The Energy Sector ..141 A. Main Sectoral Issues .141 B. Demand Management and Prices .142 C. Measures on the Supply Side .143 D. Investment and Its Financing .144 E. Sector Organization and Regulatory Issues .145 F. Privatization and Private Sector Investment .146 IV. The Agricultural Sector ..147 V. The Social Sectors ..152 A. Introduction .152 B. Reforms in the Education Sector .153 C. Health and FEamily Planning Services .155 D. Social Insurance and Social Assistance .157 VI. Inffstructure ..159 VII. Housing ......... 159  xi Uap2 No. CHAPrER 5: MEDIUM-TERM PROSPECTS . .......................... 163 1. The ^Base Case Scenario . 164 A. Energy Efficiency ................ .................. 168 B. Current Account Deficits and Financing Prospects .173 II. The 'Low' Case Scenario ..176 111. Assessment ...................................... 180 ANNEX 1: RECENT LEGISLATIVE DEVELOPMENTS ................... 181 ANNEX 2: ROMANIA: OVERVIEW OF THIE CASH BENEFIT SYSTEM1 ... ..... 193 MAP (IBRD No. 23124)  xiii LIST OF TABLES Page No. Table 1.1 Comparator Table ........... ............................ 6 Table 1.2 GDP and Production Growth .12 Table 1.3 Investment, Consumption and Savings .......... ................ 15 Table 1.4 Romania: Government Revenues and Expenditure ..... ............. 18 Table 1.5 Balance of Payments ................................... 25 Table 1.6 Romania: Outstanding Debt in Convertible Currencies, 1985-90 ......... ............................ 26 Table 1.7 Convertible and Non-convertible Currency Trade ................... 28 Table 1.8 Indices of Prices, Nominal Wages and Real Wages in the P jblic Sector ..... 38 Table 1.9 Summary of Consolidated General Government Budget . ..................................... 40 Table 2.1 Industry's Share in the Economy and the Structure of Industry .... ....... 47 Table 2.2 Romania - Shares of Industrial Subsectors in Energy Use and in Net Material r aduct ......... .......................... 49 Table 2.3 Sources of Investment Finance for Major Industrial Subsectors in 1989 ...... 52 Table 2.4 Illustrative Prices for Industrial Inputs and Products, 1990 .... .......... 54 Table 2.5 Romania - Primary Energy Sources and Uses ...................... 57 Table 2.6 Romania - Energy Imports and Exports .60 Table 2.7 Romania - Energy Use by Industrial Subsectors .................... 62 Table 2.8 Romania - Trends in Agricultural Land Use and Crop Production .... ..... 66 Table 2.9 Romanian Animal Census, Sept. 1990 ....... ................... 67 Table 2.10 Romania - Trends in Crop and Livestock Output Value in the 1980s .... .... 68 Table 2.11 Romania - Per Capita Consumpticn of Staple Foods and Beverages .... .... 73 Table 3.1 Wage (Payroll) Taxes in Romania .99 Yable 3.2 Public Investment Overhang, 199n .110 Table 3.3 Classification of State-Owned Enterprises .119 Table 5.1 Romania's Terms of Trade ..164 Table 5.2 Base Case Scenario: Production and Expenditures . .167 Table 5.3 Romania - Projected Energy Distribution, 1991-2000 and Romania - Frojected Energy Supplies, 1991-2000 . .169 Table 5.4 Base Case Scenario: Balance of Payments and Debt/ External Financing Requirements and Sources .................... 174 Table 5.5 Low Case Scenario: Production and Expenditures ......... ......... 177 Table 5.6 Low Case Scenario: Balance of Payments and Debt/ External Financing Requirements ..179  xiv LIST OF CHARTS Chart 1.1 Distribution of Economic Activity, 1965 & 1989/ Distribution of Work Force, 1965 & 1989 ........................ 11 Chart 1.2 Average C'nsumption Basked/ Distribution of Wages ...................................... 16 Chart 1.3 Romania Money Holdings ........... ....................... 21 Chart 1.4 Balance of Payments: Total, Convertible, and Ruble Trade .... ......... 24 Cbart 1.5 Distribution of Dollar Imports and Exports/ Distribution of Ruble Imports and Exports ...................... 30/31 Chart 2.1 Industrial Production/ Distribution of Industrial Investment ............................ 48 Chart 2.2 Energy Sources and Uses .58 Chart 2.3 GDP Growth and Energy Consumption .64 Chart 2.4 Oil: Production, Imports, and Net-Imports .64 LIST OF BOXES Page No. Box 1 Statistics in Romania ............. 10  xv This report is based on the work of an IBRD Economic Mission which visited Romania in October/November 1990 and on that of a number of IBRD sector missions which, at the same time or subsequently, visited Romania. The Economnic Mission was led by Farid Dhanji, and Ms. Corinne de Jesus served as secretary. Members of the Mission and other sectoral teams included: A. Tsantis (Deputy Mission Leader, Consultant) Agriculture: R. Burcroff II (Team Leader), F. Lucca, 0. Honisch, L. Bell (Consultant), H. Gencaga (Consultant), A. Grobman (Consultant), P. Winbolt (Consultant) Energy: U. Richter (Team Leader), N. Ansari, A. Adamantiades, A. Zerek (consultant) Financial Sector: G. Caprio (Team Leader), M. Slough Housing: B. Renaud, P. Heller (Consultant) Local Govermnent: J. Hicks (Team Leader), L. Ficinski (Consultant) Industry: S. Brajovic-Bratanovic (Team Leader), D. Brown, M. Meunier (Consultant), I. Lieberman (Consultant), S. Lall (Consultant) Infrastricture: W. Stottmann (Team Leader), P. Parker, T. Nulty, S. Orlic Macroeconomy: J. Hansen (Team Leader), B. Dabrowska, E. Manes, A. Ravenga, E. Jorgensen, F. Kahnert (Consultant), M. Sumlinski (consultant) Privatization and Restructuring: R. Amin (consultant), B. Lee, S. Klaue (consultant) Social Sector: L. Fox (Team Leader), R. Harbison, G. Sinclair, N. Barr, S. Sinding, I. Szemo Mrs. Karin Gill is responsible for production of the report. Mr. E. Asfour (consultant) assis!ed in updating the report following a Bank mission to Romania in June 1991.  EXECUTIVE SUMMARY INTRODUCTION i. Romania has embarked upon a fundamental transition from a centrally planned eco-omnic system to a market oriented one. It is doing so at a time of major crisis. Romania is one of the largest East European countries, with a land area and .*,isAation (23 million) equivalent to Yugoslavia and second only to Poland. Its resources include ii agricultural land and extensive forests, large deposits of coal and lignite, significant but fast depleong oil and natural gas reserves, and various other mineral deposits. Romania was a large net exporter of agricultural and food products until the early 1980s. The agrarian roots of the economy persist as, until recently, over half the population lived in rural areas. The Communist Party which came to power in 1948 nationalized most privately held property, collectivized agriculture, and established a central system of planning and control. Building on the hydrocarbon and other mineral resources, governments since the 1950s have pursued rapid industrialization that emphasized oil refining and petrochemicals, metallurgy, and machinery and equipment. Rapid growth of industry raised its share to over half of GDP and led to an overall growth of output of 6 to 8 percent per year until 1980. ui. Ceausescu's regime, which began in 1965, was marked in its early years by distancing the country from the Soviet Union, a growing rapprochement with the West, and a cultivation of ties with developing countries. Romania became member of the World Bank and the International Monetary Fund in 1972. Increasing credits from OECD countries and international organizations helped the country build up its capital stock and achieve the highest growth rate of any CMEA country in the 1970s. Foreign debt accumulated and reached $13 billion by 1980. The drying up of credits and the heavy debt burden led to a decision in 1981 to repay all the foreign debt, which was in fact achieved by the end of the decade. The economic cost was high, however. Imports of new machinery and equipment from the West were stopped, which rendered the capital stock increasingly obsolescent and perpetuated old, less efficient, technologies. In addition, imports of raw materials and spare parts were squeezed, and exposure to modern products and production methods through trade also ceased. Investments in the 1980s were maintained at a high level in industry but were shifted to huge showcase and low productivity projects in the latter part of the decade. Wide social repression attended these policies: the supply of consumer goods declined sharply, electricity for households was restricted, and the practice of illegal abortion resulted in one of the highest maternal mortality rates in middle income countries. Despite considerable data falsification, which makes the reading of the historical record difficult, it appears that growth slowed down considerably in the 1980s and stagnated in the second half of the decade. At the end of the decade, production and per capita incomes were probably no higher than at the beginning.  ii iv. In December 1989, Ceausescu was ousted, and Romania joined other former communist countries in seeking to establish more open political and civic institutions. The first year and a half of post-communist history have been marked by the adoption of a bold and comprehensive economic reform program and the appearance of wide macroeconomic imbalances which threaten its successful implementation. v. The Government's reform program has been carried out at a hectic pace. Early in 1990, central planning was abolished, the number of Ministries reduced by half, and the monopolies of Foreign Trade Organizations ended. Two successive steps to liberalize and adjust domestic prices were taken, in November 1990 and April 1991 and were accompanied by substantial devaluations; a third step in price liberalization was taken in July 1991. Distribution of cooperative land was sanctioned and promoted under a Land Law, following a large scale "spontaneous" takeover of cooperative land by farmers. A large part of state-owned enterprises in all sectors was converted to commercial joint stock companies registered under a new commercial law, and 30 percent of their shares are to be distributed free to adult citizens under a Privatization Law. A number of restrictions on the formation of new private enterprises were lifted and a liberal Foreign Investment Law was enacted. A two-tier banking system has been established with an independent central bank and the former specialized financial intermediaries converted into universal banks; entry of foreign banks has been encouraged. The fiscal system has undergone preliminary reform: the turnover and income tax systems have been modified; the budget's traditional role as a conduit for transfers of enterprise surpluses between enterprises has been eliminated; and a substantial devolution of expenditure authorities to local governments has been enacted. To protect the population against extreme hardships during the transition, an unemployment compensation fund has been established and the existing social insurance system to protect the poor has been strengthened. vi. At the same time, there has been a serious deterioration in economic performance. On the output side, GDP fell by over 7 percent in 1990, with industrial production falling by about 17 percent; the falling trend continued into the first five months of 1991 at about the same rates. This fall is attributable to the disruptions caused by the revolution, by a shortening of the workweek, a contraction of exports to the CMEA countries and a shortage of foreig exchange to finance imports of raw materials, particularly oil. On the demand side, while investment declined substantially (from 30 percent in 1989 to 20 percent of GDP in 199C), consumption shot up in 1990 as large wage increases were awarded in an effort to lift the climate of harsh personal and consumer repression and part of the huge excess currency balances were utilized; an import boom resulted which, coupled with a decline in exports, led to an external current account deficit--of about 6 percent of GDP. As Romania was unable- -despite the absence of external debt--to secure access to international capital markets, the deficit was financed entirely by a drawdown of reserves, which dropped from $1.8 billion at the end of 1989 to $0.4 billion at the end of 1990, equal to two weeks' imports. In addition, a surplus balance in Transferable Rubles of $0.5 billion was turned into a deficit of $0.9 billion during the year. The Govemment  iii tightened macro-policies in the second half of the year and achieved a nearly balanced budget at year's end. THE DEVELOPMENT AGENDA. SYSTEMIC REFORM, SECTORAL ADJUSTMENT AND MACRO- STABILIZATION vii. The economy of Romania is facing very great difficulties. The inherited capital stock is old and largely obsolescent, Energy intensity in production is several times higher than in OECD countries and among the highest in the region. The economy's indigenous resources of oil and natural gas are being depleted and production is secularly falling; the economy's dependence on imported energy is thus growing rapidly. The production structure is strongly biased towards producer goods industries - steel and nonferrous metallurgy, machinery, oil refining, chemicals - where many enterprises are internationally uncompetitive, and where supply is widely inconsistent with the dewiands of the domestic market. The majority of enterprises operate in highly concentrated settings, are vastly overmanned, have not had to pay regard to balance sheet constraints, and have had few incentives to operate efficiently. Agriculture, consumer goods industries, and the service sectors have received insufficient attention and resources. All sectors have operated in highly distorted price and incentive settings. Economic policy must now deal with the very great challenges of achieving deep seated systemic reform, securing major realignments in the economy's production base, and implementing a difficult macro-stabilization effort in the wake of declining output and the serious disequilibrium in the external accounts. Romania has started its reform program, however, vith some substantial advantages: it has a relatively skilled work force and a well developed social security system; the valuable oil and natural gas resources continue to meet the larger part of domestic energy needs; and Romania started with virtually no foreign debt. viii. This report is largely devoted to analyzing and advising upon the (i) macro-economic policies (ii) systemic reforms and (iii) sectoral adjustment policies that will be required to enhance the chances of success of the reform program. At the outset, however, a number of critical conditions, which underlie all the report's recommendations, deserve special emphasis. Firs4 imposing finacial discipline upon enterprises will be indispensable for ensuring the success of macro-stabilization and reform policies. Only if enterprises are held to "hard' budget and credit constraints can the budget be stabilized, credit restraint maintained, incomes policies prove efficacious and interest rates ultimately freed. Enterprise wage, price and investment decisions can only be properly made, and production efficiencies stimulated, in an environment where balance sheet realities are observed. Second, it is especially important that enterprises do not secure access to credit from the financial system to cover losses or in order to postpone adjustment. This would not only impart financial instability to the economy, it will seriously damage the role of the financial system in allocating resources to activities of highest return; good borrowers with good investmen; projects will be crowded out, and growth will suffer. Thir4 enterprises which cannot cover their operational costs and generate negative value-added should, if analysis shows them to be unviable in the new market environment, enter bankruptcy proceedings and be liquidated. A number of entesprises may be expected however, to face temporary  iv and not fatal difficulties. For these enterprises an emergency program of restructuring will need to be instituted. Finally, the unemployment that will result from enterprise closures, and from enterprises seeking cost efficiencies through reducing employment rolls, will necessitate the swift implementation of the government's emergency, transitional programs of ulnemployment and income support. ix. While these general considerations should undergird the policies aimed at achieving a successful transition, the report also identifies a core development agenda, of strategic intentions and actions, which merits focussed and continuing attention in the near and medium terms: (i) The progress thus far attained in price liberalization should be maintained and consolidated, while remaining distortions should progressively be removed; (ii) Continued implementation of the macro-stabilization effort is a fundamental requirement. At the same time, the associated monetary, fiscal and exchange rate polices should be designed in a manner to promote structural transformation and particuhtirly facilitate tlue efficient alocation of foreign exchange, investment and energy r',sources; (ii) Reducing the economy's energy intensity is of highesi priority in securing overal macro- economic adjustment, as well as achieving competitiveness at the micro-economic level; (iii) An export-led development effort is the key to overcoming the shortage of foreign exchange and allowing the modernization of largely obsolescent production facilities; (iv) Privatization efforts should be intensified and accelerated, while the rapid promotion of competition in all branches of activity, and the stimulation of small scale private enterprise start-ups will be indispensable to achieving the efficiency gains that underlie a prompt supply response; (v) Finally, as noted earlier, as economic restructuring will inevitably entail increases in unemployment, the early development of admninistrative networks to deliver unemployment benefits, as weUl as other programs of the social safety net, is of high priority x. The actions and policies to support these goals are intricately linked. While the design of the reform and adjustment programs have, therefore, to be comprehensive in nature, they need also to be internally consistent, particularly avoiding actions in one area which impede or retard progress in others. In the sections which follow, each of these areas is examined in turn with respect to present policies and intentions; the accompanying suggestions are aimed at defining and reinforcing these complementary linkages.  V MACROECONOMIC STABILIZATION AND PRICE LIBERALIZATION xi. The 1991 stabilization program, supported by the IMF, is aimed primarily at ensuring that the changes in the price level engendered by successive price liberalizations should be achieved without embedding an inflaticnary process in the economy. The program also aims at reaching a sustainable balance of payments position, at rebuilding foreign exchange reserves, and at containing the decline in output. xli. The chief stabilization instruments on the domestic side are a balanced budget--with strict limits on subsidies to enterprises and households; controls on money and credit expansion--with no bail- outs of (unviable) firms in difficulty; and an incomes policy to prevent the emergence of uncontrolled cost-push inflation. On the external sie ihe program instituted a dual exchange rate system, with exporters retaining 50 percent of gross exports proceeds, with the remainder being surrendered to the Government. The Government uses its share of exchange earnings to import energy and important raw materials at an official rate that has been considerably lower than a free market rate established in an interbank market. The Government has since announced its intention to unify the rates. aii. The successive price liberalizations of November 1990, and April and July 1991, have progressively reduced the scope of government price setting in the economy. Only five consumer food items remain subsidized and controlled at the retail level (bread, sugar, edible oil, milk and butter). Price controls exist for some subsidized basic needs (rents, transport, and energy). Most producer and consumer prices can now be freely set between economic agents. The most important exception to this rule are energy prices. Domestic prices of crude oil, electric energy, natural gas (and a few raw materials which are imported) remain controlled. These prices, as well as for certain agricultural inputs, are in addition implicitly subsidized, by being imported at the official exchange rate. Between October and May, as a result of the price liberalizations, the consumer price index rose by some 140 percent. xiv. As of mid 1991 the Government had apparently succeeded in achieving the program's fiscal and credit targets, although weak exports and a shortfall in expected foreign resources have put pressure on the external account and output has continued to decline. Price subsidies in the budget (for consumer goods and services and for domestic oil, coal and other minerals) reached 7 percent of GDP in 1990. With the reduction of the list of subsidized household consumption items and a gradual price adjustment for energy and mineral products the subsidies are programmed to drop to 3.2 percent of GDP in 1991. xv. Containing the incipient inflationary threat has been difficult both because of a weak supply response and the existence of large excess monetary balances. However, by mid-1991, it appears that the price adjustments generated by the successive price liberalizations had largely eliminated the monetary overhang, with a corresponding increase in the income velocity of money. At the same time, however, enterprises have accumulated very substantial inter-enterprise arrears which now amount to  vi between 15-20 percent of expected GDP. Interest rates, although liberalized in principle at the initiation of the stabilization program, have moved slowly and remain negative in real terms with respect to the expected rate of irnflation. xvi. To prevent price rises- from fuelling a cost-push inflationary spiral, the Government instituted an incomes poiicy. This policy has attempted to control the growth of individual wages, through highly punitive taxes applied if enterprises breach ceilings on individual wages. In addition to freezing rents, household energy prices and urban transport tariffs, the Government has provided partial compensation payments to wage-earners for increases in the prices of a number of goods and services which figure prominently in the household consumption basket. Average wages (including the fixed compensation payments), fell 23 percent in real terms between October 1989 and March 1991. However, wage adjustments in April narrowed the real wage decline to 6 percent in May 1991. In July 1991, the Government announced that wages will be indexed at 40 percent of the rise in consumer prices until end 1991 (in addition to taxing above-average enterprise wage bills). xvii. The achievement of most stabilization targets to date is commendable. At the same time, the very recent July 1991 price liberalization, the impending unification of the exchange rate, and the surfacing of large inter-enterprise arrears pose new issues for policy. In these circumstances, it is appropriate that the Government is continuously reviewing the measures it is applying to stabilize the economy. Stabilization must rem,-in an overriding objective. The dangers of a major inflation emerging in the wake of price liberalization (as enterprises in difficulty seek budgetary support and as workers seek to maintain their wages in real terms) is ever-present and must be deflected in order to allow the fundamental systemic reforms beiug instituted to take hold. At the same time, these new developments place an ever greater premium on the Govemrn'ent achieving consistency among the various stabilizatior and reform measures. It does require that near fiscal balance be maintained. Price liberalization and exchange rate unification could put pressure on this objective, as demands for subsidies begin to mount; these demands will need to be resisted and the full pass through of higher import costs of energy and raw materials be allowed The Government will need to move firmly in imposing financial discipline upon enterprises, and in restructuring or closing down those loss-makers which are the major source of the mounting problem of arrears, so as to allow monetary policy to effectively combat inflationary pressures. Unemployment compensation, and other aspects of the safety net, will need to be vigorously invoked to cushion the impact of economy-wide restructuring, at the same time that these benefits are set at levels consistent with available funding. Likewise the incomes policy should seek to prevent the emergence of cost-push inflation, while facilitating the realignment of cost structures to permit enterprises to become competitive at the new exchange rate. Stabilization is, undoubtedly, a complex balancing act: Chapter 3 of this report highlights those areas where consistency in the application of macroeconomic policies commends attention.  vii REDUCING ENERGY USE IN THE ECONOMY xviii. Reducing energy intensity should be one of the highest priorities in Romania's reform program. The intensity of energy use in the economv is 3-8 times highe~r than in OECD countries, and among the highest in the Central and Eastern European region. It has led to an acceleratirig depletion of Romania's oil and natural gas reserves. It has also led to a growing import requirement, where despite considerable re-exports of refined oil products, the economy is becoming increasingly dependent upon imports to satisfy domestic needs. High energy intensity is traceable to two causes. First the structure of production is heavily biased towards industry and, within industry, towards energy-intensive heavy goods production. Second, the technologies used in the fabrication of goods are often very heavily energy-intensive, e.g., a considerable proportion of the steel industry continues to use open-hearth furnaces, cement is produced by the energy-intensive wet process and so on. Unlike other countries, these technologies were not upgraded in the aftermath of the two oil-shocks. mix Realistic energy pricing is the first step to achieving increased energy efficiency. Domestic electricity prices, particularly to households, but also to industrial users, are particularly low in international comparisons. A rapid adjustment would be a shock in the short run, since it will, undoubtedly, raise considerably the production costs of energy intensive industries, as well as agriculture and transport; it will multiply the fuel and electricity costs to households. However, reducing energy demand through realistic pricing will yield a high growth dividend to the economy. It will slow the pace of depletion of Romania's oil and gas reserves, and limit, if not reverse in the short-term, the growth of energy imports. Both effects will deliver considerable resource savings to the economy, alleviating the chronic shortage of foreign exchange. At the same time, reduced energy intensitv at the enterprise and plant level will assist in achieving the vitally important cost-efficiencies required to make firms competitive both domestically and abroad. Realistic pricing would also reduce budget subsidies to the energy producing sector and to households, and enable the sector to finance urgently needed, high return rehabilitation investments, as well as having a favorable long-term effect on the environment. xx In the first instance, steps to introduce economic pricing will need to be coordinated with changes to the exchange rate regime where, as noted earlier, a considerable implicit subsidy to energy imports and use is currently entailed. The goal should be the adjustment of domestic prices of primary energy sources - crude, petroleum products, natural gas and lignite - to international levels. The Government announced in July 1991 that domestic energy prices will be reviewed monthly, and on a quarterly basis for natural gas, to bring them in line with international prices. It is recommended that the adjustment period be short. Second4 household energy prices have been frozen for some time and are now a Eraction (less than one tenth) of comparable international prices. It is recommended that a phased program of raising household energy prices to economic levels be developed and instituted. Fmahl, prices of electricity supplied to industry also need to be raised. In principle electricity prices should be raised to parity with economic costs. However, in view of the severe price shock to enterprise cash-flows and profit statements, it is recommended that electricity prices to enterprises be raised  viii gradually in the next eighteen months. By the end of 1991, all financial subsidies should be removed. By the end of 1992, energy prices should reflect long range marginal costs. xxi. Achieving major savings in the use of energy in the near term will, in addition, need to be accomplished by the closure of facilities where obsolescent technologies, and the lack of any apparent comparative advantage, deny any prospect of solvency for the plants and enterprises concerned. Although considerable uncertainty exists in the present climate of rapidly changing relative prices, nonetheless it may reasonably be expected that material and energy costs for a number of enterprises will approximate or exceed earnings, leaving insufficient income to meet wage, dividend and interest costs, i.e. a number of enterprises will generate minimal or negative value added. Aluminum smelting, several steel plants, diverse machine-building enterprises, and certain facilities in the chemical and cement sub-sectors do, on preliminary investigation (see Industry Chapter in Volume II of this report), appear particularly vulnerable in this regard. Continued operation of these facilities will require subsidies which, if provided, would divert scarce budgetary funds, exercise further pressure on budget stability, and exact high long-term real resource costs on the economy. In these circumstances the plants should be closed, as part of the general process of structural adjustment in which the economy's productive base becomes more closely aligned with its competitive potential. These policies will, of course, need to be complemented by energetic provision of unemployment compensation, retraining and assistance to workers in finding new jobs. INCREASING FOREIGNd EXCHANGE EARNINGS xxi Romania faces very great challenges on the external front. The demise of the CMEA has created a very sharp and serious downturn in exports to the bloc (some 50 percent of all exports), while the transformation of CMEA pricing rules to international levels, with transactions payable in hard currencies, has led .o a very sharp decline in imports, especially of oil, natural gas and raw materials. On the convertible currency front, the balance of payments surpluses achieved through much of the last decade, were largely achieved through the export of refined oil and chemical products (60% of all convertible exports) and through a drastic compression of imports. In particular, the import of machinery and equipment fell from an annual volume of over $1 billion at the beginning of the decade to about $0.1 billion in 1989, leaving a legacy of widely obsolescent plant and equipment, with technologies some 15 to 20 years behind best practice. The economy's requirements for modernization in the competitive areas of its capital stock, supplemented by growing demands for imported consumer goods, now engender enormous calls on the very limited earnings of convertible foreign exchange. X10ii In these circumstances, a key strategic focus of the reform program should become the enlargement of exchange resources through competitive exports and efficient import substitution. While the challenges are daunting, Romania does have a number of advantages. As mentioned, the absence of debt may allow it to more easily use foreign borrowing to transform, and render more efficient,  ix production capacity. The workforce is literate and skilled, and wages are relatively low in international comparison, allowing for competitive advantage in a number of export endeavors; in the early eighties the country was a competitive exporter of textiles, wood-products, machinery and light consumer goods to convertible cuTrency markets, and can, in time, recapture lost market shares. Agriculture holds great export potential. !. addition, the expansion of tourism holds considerable promise. xxiv. In the final analysis, export success will rest upon improved competitiveness and improved efficiency in the use of resources. It may be noted in this context that international experience has repeatedly demonstrated the primary and vital importance of a stable macro-environment, a realistic exchange rate, and a liberal tariff regime in achieving export success. While domestic balance and a climate of stable prices may be expected to follow the successful implementation of the stabilization program, tbe early unification of the exchange rate, with equal access to foreign exchange for all p-tential exporters will be indispensable to early export success. xxv. A tariff code was adopted on January 1, 1991, largely to assure compliance with GA1T regulations. It is intended that will be replaced later in 1991 by a revised code which should be either a uniform tariff rate on all products, or a simple ad valorem schedule with a few rates. In addition, it is extremely important that exporters be exempted from duties on imported goods used in export, in order not to set them at a competitive disadvantage. The Government should quickly rescind export bans and recently introduced export quotas. ACCELERATING PRIATIATION, PRIVATE SECTOR DEVELOPMENT, AND COMPETITION xxvi. The large bulk of property in Romania, whether in land, buildings, farms, businesses belongs to the State. Transferring a large part of this patrimony to private ownership is a fundamental part of the transformation which is sought by the Government. The privatization program is still evolving. Private property existed in marginal lands, cooperative light industry and in hovcing The continued absence since the revolution of wegl defined private property rights presents prospective private investors and prospective buyers of public property, including foreign investors, with many legal and bureaucratic difficulties. This needs to be remedied. xmi. A distribution of cooperative land, the sale of public housing and the decision to transfer a 30 percent share in a number of State-owned enterprises to the Romanian public, are the main privatization programs that have been started. About 6 million ha. of cultivable land belonging to cooperatives (out of a total cultivated area of 10 million ha.) are to be distributed in 2-3 years. It is estimated that between 1.6 to 3 million ha. of cooperative lands have already been spontaneously privatized. Disposal of state farms, which own 3 milliona ha. of the most productive land is not dear, they may fall in the category of enterprises to be partly privatied. To avoid insulating the state farms from privatization, it is recommended that these lands be leased, sold, o; distributed.  x xxviii. The status of urban land is awaiting thc passage of a draft urban land law, which would resolve such practical issues as sale or lease of State-owned retail outlets built on State land to private traders (including food markets), as well as office or building space to private businesses. It would also facilitate the sale of housing apartments sharing the same land property. The large public housing stock has been transferred to local governments for sale, along with its financial liability for rising maintenance costs in the face of low fixed rents. Data on the volume of house privatization is not available, but sales are being subsidized at low fixed interest rates below the rates being offered to depositors. This policy has the potential for severely destabilizing the finwncial system. It should be rescinded, and policies made consistent with other aspects of the stabilization program. xxix. The legislative framework for privatc business activity was quickly set up in 1990/91. New laws legalized small-scale private sector activities (about 80,000 licenses, mostly for very small businesses, have been issued) provided the framework for foreign investment in the economy and set up an Agency for the Promotion of Foreign Investment; regulated business organization, registration and dissolution in a new Company Law; and provided for modernizing accounting practices. Most important is a law on "Restructuring of State Enterprise Units," which provides for converting state- owned enterprises into two categories: enterprises that are to remain fully state-owned, and which are called autonomous public enterprises (after the French Regie Autonome, RA), and a category of commercial (joint stock companies, or CCs), the shares of which are owned by the State at present but 30 percent of whose shares are to be distributed to adult citizens. A Privatization Law, passed by Parliament at end July 1991, establishes the manner in which state assets are to be privatized. A State Ownership Fund (SOF) is to be established in which 70 percent of the value of assets are to be deposited; in addition five Private Ownership Funds (POFs) are also to be established, which will together hold the remaining 30 percent. Eligible citizens will hold shares in each POF. The SOF and the POFs will jointly be responsible for bringing enterprises for sale. The scheme is an innovative and fitting vehicle, in the Romanian context, to achieving the government's privatization objectives. To facilitate the highly important small scale privatization on an accelerated timetable, a Government Commission is being appointed to identify privatization candidates which are to be disposed of in the next eighteen months. A National Privatization Agency was established in 1990 to design and oversee the privatization process as well as to promote private sector development. xxx The conversion of public enterprises into commercial companies andRegiesAutonomes is almost complete for the industrial sector but lags behind for agricultural farms and for enterprises controlled by local governments. The criteria for classifying companies a; RAs (which entitles them to budgetary subsidies) has been generously applied with the result that a large number of entities, which are neither natural monopolies nor traditional public utilities have entered the list. The Government is now reviewing this list with a view to paring down considerably the number of RAs. This initiative is strongly supported and it is recommended that all enterprises in potentially competitive fields of activity (other than public utilities), should be reclassified as commercial companies.  xi cou. The growth of private enterprise is still hampered by various restrictive regulations for entry and by difficulty of access to credit, raw materials and assured supplies from monopolistic public enterprises and local authorities. Future new entries, enterprise restructuring and an open trade policy, should help in improving competition and stimulating efficiency. However, the current high concentration and vertical integration in industry weakens competition; this seems to have been compounded by a recent trend toward forming associations and trusts. It is recommended that anti-trust legislation be prepared to address the issuc, and that deconcentration be encouraged through separation or sale of ancillary parts of public enterprises not directly related to their main activities. mxAi. Several measures are suggestcd by the Report to accelerate privatization and improve competition. First, a well defined medium-tcrm privatization strategy, action programs and time schedules for the various sectors or enterprises need to be quickly prepared, particularly for small enterprises. Second, the institutions established to implement the process need to have their objectives, procedures, and respective privatization and governance roles codified. Third, State farm lands should be leased, sold or distributed to farme:s. Fourth, restrictions and red tape in regulating entry of domestic and foreign private investors should be reduced. Fifth, anti-trust legislation needs to be prepared, and deconcentration action be pursued. Finally, conversion of commercially oriented RAs to commercial companies is strongly recommended. WAGES, UNEMPLOYMENT, AND THE SAFET NET xxxiii. Price adjustments, financial discipline and enterprise restructuring will unfortunately result in unemployment in the short- to medium-term. Judging by the low but rapidly rising unemployment so far (2 percent in April 1991 which may go up to 8 rercent by year end), and by the accumulation of huge enterprise arrears, the State-owned enterprises do not seem to have been able yet to shed redundant labor or close down unprofitable operations. Assured employment has been a long tradition. Present legislation does not, in fact, provide for termination of redundant workers (except for absenteeism or misbehavior). It is strongly recommended that legislation be prepared defining the rights and obligations of employer and employees with respect to termination of employment, including the right of managers to dismiss employees for economic reasons. xxxiv. In the medium term, the growth of private enterprise and of the more efficient and competitive public enterprises should absorb part of the unemployed labor. Instituting housing reforms that lead to growth in house maintenance and construction, is also an important step to labor absorption in that sector. In the short term, the Government may increase the chances of employment by also (i) removing obstacles to labor mobility, including regulations discouraging part-time employment, flexible hours, and short-term contracting, (ii) keeping unemployment benefits below the minimum wage to encourage job search; and (iii) keeping minimum wages low to encourage private firms to hire workers.  xii xxxv. To protect the unemployed, an extra-budgetary Unemployment Fund was created in February 1991, financed from a tax of 4 percent on the wage bill of each enterprise. A program was also set up to establish unemployment offices, to provide services as well as to administer unemployment benefits. The program also envisages setting up emergency retraining schemes. Monthly cash benefits to the unemployed are close to the minimum base wage. It is estimated that total benefits may rise to 0.8 percent of GDP (at an unemployment rate of 7 percent). It is important that benefit levels and coverage be continuously reviewed to ensure that expenditures are consistent with attaining overall fiscal targets. xoxvi. Romania has also in place social assistance programs which provide income support through family allowances and pensions, and modest local social welfare, primnarily targeted at the elderly, the disabled and the handicapped. These programs include maternity benefits, scholarships to low income students, disabled and sickness benefits, children allowances and monthly payments to mothers with three or more children. The current emphasis on income support is appropriate, and should be maintained. In view of the rapid price adjustments and rises, it will be necessary to review periodically the minimum levels of unemployment benefit, sick pay, pensions, and family allowances to ensure that they provide an adequate income floor given the resources available. Meeting these needs and the social assistance needs will prove difficult under current tight budget conditions. The welfare programs are financed F-om the budget and are expected to cost 1.4 percent of GDP in 1991. To help fiance rising welfare costs, the Government may wish to consider reducing social insurance benefits if they create adverse incentives or are not effective in alleviating poverty. RESTRUCTURING STATE-OWNED ENTERPRISES xxxvii. It is clear from the previous paragraphs that success of the systemic reform will depend vitally on the success of the public enterprise in adapting themselves quicldy to market conditions and turning into efficient producing units that can stand up to market competition. The State, which will remain for many years the full or majority owner of these enterprises, has a primary responsibility, as owner, of determining which are to be sold or closed, and to help in the restructuring of enterprises that are potentially viable but which face serious difficulties. Much of the necessary legal framework for enterprise restrucuring is in place. oxcviii. An Enterprise Restructuring Fund to help in the restructuring process has been created and will be funded by a tax on windfall inventory revaluation gains as well as a proportion of the proceeds from privatization. Resources available to the Fund are likely to be limited; inventory revaluation is a one-time effect, whose yield, in any event is uncertain, while the proceeds from privatization may take several years to accrue. There remains considerable discussion, both in Romania as well as in other countries in the Region, of the exact financing role govemments should play in restructuring. In view of its limited resources in relation to needs, it is recommended here that the Fund  xiii should not directly provide cash injections to ailing firms or take equity participations, but its monies be applied towards conduct of necessary studies, preparation of strategies, and development of supporting institutions (consulting and technical advisory services). It is also recommended that the Fund's administrative authority be appointed, and develop its policy guidelines as soon as possible. idx Because of the complexity of restructuring and the risks of wasteful use of resources, the Report recommends, first, that an overall restructuring strategy for CCs be developed at an early date and, second, that an agency be designated with clear terms of reference for the preparation of a restructuring strategy for RAs. Restructuring ultimately occurs at the enternrise level. In view, however, of the heavily distorted production structure, where sub-sector downsizing will likely eliminate numerous enterprises with considerable loss of jobs, it is suggested that subsector strategies, should be developed for selected subsectors with clear prob!ems. These should be identified and their studies commissioned as soon as possible. xl. Financing the restructuring of commercial companies should primarily be the responsibility of the enterprise itself, supported by unsubsidized loans from the banking system. In the case of the RAs, the Government is the sole owner, and may have to contribute to financial plans for restructuring from its own resources. Nevertheless, commercial principles of profitability should be a guiding principle for the RAs as well, with any socially necessary price subsidy being explicitly financed from the budget. In both cases, however, reform of the accounting system is a prerequisite for enabling sound evaluation of .he enterprise's financial status. In particular, it is recommended that the unrealistically low Lv't_. of the capital depreciation allowance which affects the eva!uation of both the value and profitab-.iiy of enterprises be brought in line with international standards. xai. Restevcturing a potentially competitive enterprise involves either the transformation of the enterprise in it, -tutirety or liquidation of its non-profitable segments and conversion of the rest. A non-viable enterpris ihich is not suitable for total or partial conversion would have to undergo a systematic liquidation, T e selection of measures to be taken for enterprise restructuring should be guided only by the least 'o.. principle, i.e., the minimum investment required to achieve the goaL The owners of state enterprise . represented by the Government ministries and local governments in the case of RAs, and of the autonomous Funds (SOps and POFs) in the case of the CCs, should develop the goals and strategy for restructuring individual enterprises, including setting hard budgets and requiring that the program be bankable. However, the detailed design for and implementation of restructuring should be the responsibility of the enterprise management alone. To reduce the cost of restructuring Prime candidates include metallurgy, machine builu g, and segments of the chemical industry, and among RAs, the energy sector, mining and railways. These industries contain large enterprises and a signficant number of them are big loss-makers. In addition, the steel and chemical industries are highly energy inefficient, and are among the worst industrial polluters in the country. The recent IBRD Technical Assistance Loan provides funds for undertaking these sub-sector studies.  xiv it is recommended that local restructuring services institutions (private and public but autonomous) be created, which would act as consultants and seek foreign expert assistance as needed. xlii. In Romania, the issue of separating the functions of ownership and governance has been addressed in the case of the CCs through the creation of Private Ownership Funds and the State Ownership Fund to manage ownership rights of the state in CCs. The composition of the board of the SOF and the severance of its ties to the Government budget assure its independence and its separation from the Government ministries and agencies. However, the RAs own their patrimony, their boards are appointed by sector ministries or local govcrnments, and they are ultimately dependent on national or local budgets for financial support. In restructuring, the role of the State as an owner should be the same as that of a private owner who is interested in profitability, as State resources are a national asset and need to be allocated with the same interest in efficiency. The State, as a governing body, should avoid preferential treatment of its property and make sure that subsidies are discontinued and bailouts are not funded. RATIONALIZATION OF PUBLIC INVESTMENT x1iii. Stabilization programs generally lead to a severe contraction of investment. This is already apparent in Romania. However, it is very important that investment be increased in the near future, as rehabilitation of the capital stock and new investments in competitive activities are essential to obtain a supply response. It is equally important that investment decisions are justified by market criteria and are undertaken only in projects with high economic returns. At present, there is a huge stock of public investment projects that have been started but not completed. This alone vill ensure that the claim of the public sector on resources, whether domestic or in foreign exchange, will remain large. It should not be allowed, however, to "crowd out" investment by the nascent private sector, e.g., through credit or exchange restrictions. xliv. Four areas, electricity, mining, transport and land reclamation (which constitutes the bulk of the project overhang recorded for agriculture) account for close to three quarters of the total overhang. To rationalize the overhang of unfinished projects, and evaluate future projects, top priority must be attached to creating an up-to-date economic and financial project evaluation capability in Government, the banking system and the enterprises. At present, new projects are not systematically subject to economic and financial analysis; only legal and technical aspczts are examined in detail. This is a long term effort that should be started immediately, building on existing modest capability, a training program in project evaluation is a priority. xlv. The work of the various sectoral teams who contributed to this report suggested a number of sectoral investment priorities. A list of proposed investment priorities is contained in Chapter 3.  xv SECTORAL ADJUSTMENT xlvi. Stabilization, price liberalization, reducing energy intensity, export expansion, rapid privatization and private sector development, building social safety nets, restructuring enterprises, and rationalizing public investment together define a strategic agenda for immediate attention. Together, rapid action on the specific elements which define programs in these areas, should lay the basis for future growth as well as provide a considerable impulse to the Romanian reform program. Complementing rneasures to strengthen enterprise capacity to deliver a supply response, are specific programs of sectoral adjustment. The main report provides a detailed analysis of the policies and programs that mav be considered in the financial energy, industrial, agricultural, infrastructural and housing sectors#' While the recommendations entailed are too voluminous to summarize here, nonetheless, some general themes merit an encapsulated statement. First is the importance of sustaining the movement to market pricing in industry, agriculture, and energy. Second is the importance of rationalizing investment policies. In the near-term, given the great shortage of foreign exchange and investment resources, investment should be concentrated on upgrading plant and equipment, and should be particularly aimed at reducing energy intensity. In the industrial sector, further expansion on the refinery, chemical, metallurgical and machine building sectors, should be very carefully analyzed and screened, as intermational competitiveness has yet to be demonstrated in these areas. In agriculture, further expansion of irrigation should be avoided as farmlands under irrigation are likely to contract in response to the reforms underway in the sector. In the energy sector, priority should be given to rehabilitating existing generating capacity, postponing further expansion of the nuclear power program, and rehabilitating oil and gas extraction facilities. Telecommunications and Roads should receive higher priority than airport upgrading or port expansion. The third general theme of sectoral adjustment is the vital importance of institution building. The years of working under a command economy have, for unde'rstandable reasons, deprived Romania of the governmental institutions and skills needed to build the analytical, strategic, and implementation capacities required to deliver effective programs of adjustment. In all the sectors under consideration, it is suggested that technical assistance be sought to assist Romania to rapidly develop the requisite institutional capacity. THE MEDIUM-TERM RESPONSE xivii. The report contains (Chapter 5) a number of projections of the possible future evolution of the Romanian economy. In view of the immense changes which are occurring these projections should not be regarded as forecasts, but rather as plausible bounds of adjustment in the a' The Social Sectors - Population, Education and Health - are covered in a separate report.  xvi economy to the changed incentives, signals, and mechanisms of economic management. Two scenarios are developed. The first, a "base case" scenario rests on the fundamental conjecture that the stabilization program will be maintained and that the systemic reforms embarked upon will be deepened and forcefully implemented in the coming years. In particular, the scenario is underpinned by a trajectory for a decline in energy consumption in the economy, which, if accomplished through the policies discussed earlier, will yield handsome dividends by way of increased growth and higher standards of living. A second scenario, provided for ilustra ive purposes, is developed on the supposition of a wealdy instituted reform program with only modes. gains in sectoral restructuring, in achieving energy efficiency, and in expanding exports. xlviii. In the base case, it is envisioned that the industrial sector will operate under the influence of two different trends: heavy industries, and industries which are highly energy intensive will contract in size, or else in certain segments, disappear altogether; light industry, particularly in the manufacture of consumer goods, will grow in response to both external and internal demand. The joint impact of these forces imply that the economy will, in the next few years, experience a considerable downsizing of the industrial sector. The agricultural sector holds great promise and, provided the appropriate policy framework and ancillary institutional supports can be rapidly developed, should grow rapidly. The services sector has been traditionally neglected in all pre-reform economies; the demand for services is, however, highly income elastic, and the sector is likely to attract considerable numbers of entrants. In addition to the development of trade, banking and communications, of household- oriented services such as restaurants, specialized retail stores, and personal services, tourism could also expand rapidly after initial investments are made in the sectc-. In the medium term, therefore, structural change should result in a smaller (but more efficient and competitive) manufacturing base, a somewhat larger agriculture, and a much expanded share of services in total value-added. xlix. In the base case, considerable economic restructuring and adjustment is concentrated in the next five years, after which the basis is established for higher, sustained, long term improvements in standards of living. Growth averages about 3.5 percent per annum between 1992-95 and then rises to a long term trend rate of about 5 percent per annum. Externally, tbe economy's convertible currency terms of trade remain roughly the same through the decade. Great uncertainty, of course, attends the development of the CMEA markets. In this scenario, little growth from these markets is anticipated and, indeed, by end 1991, except for a small volume of energy imports and specialized heavy machinery exports to the Soviet Union, Romania's trade is expected to be very largely oriented to Western markets. Exports, thus starting from a considerably diminished base, are projected to grow by 8 percent p.a. in real terms through the decade, initiated by the considerable real depreciation of the exchange rate after unification, and through export promotion and development efforts. These exports indude traditional exports to convertible currency markets, as well as growing exports of agricultural goods and of tourism. Imports, constrained initially in 1991-93 by sources of financing, are expeted to grow at 5-6 percent p.a. through the decade.  xvfi 1. The external resource gaps (trade in goods and non-factor services) associated with this scenario average $0.9 bin. p.a. between 1992-96; after 1996 they average $0.4 bln. per year. Interest on debt accumulated to finance these deficits engenders current account deficits averaging $1.4 bln. in 1992- 96 (4.8 percent of GDP), again along a declining trend; current account deficits thereafter amount to an average $0.6 bln. p.a., or about 3 percent of GDP. li. Deficits and financing of this magnitude do entail a rapid, although sustainable, build-up of debt. Total debt outstanding and disbursed climbs from $0.9 bln. in 1990 to $7.0 bln. by 1995 and reaches $10.6 bln. by 2000. The Debt/GDP and Debt/Exports ratio peak in 1995 at .24 and 1.06 respectively before declining. The debt service ratio also peaks in 1995 at 21.8 percent of exports before declining to 16 percent at the end of the decade (the result of higher exports, and lower later borrowing requirements). These ratios emerge as a consequence of the growth path discussed earlier and the implicit borrowing terms assumed. lii. It remains a fundamental policy decision for the Romanian authorities to decide what level of external debt and debt-service ratio is acceptable. At a time of low expected international inflation, a debt build-up of this magnitude should not put an excessive burden upon the economy. In various alternative simulations performed which also attempt to capture the interconnections between investment, exports, imports, and GDP, it is apparent, however, that a less successful program of recovery and growth will also entail a rapid build-up of foreign obligations - assuming, of course, that financing would be available. This fact underscores the vital importance of using the increase in foreign deb4 in the transition years, not to increase consumption, but rather for investment in projects which eam or save foreign exchange. Some uncertainty, of course, attaches to the amount of borrowing Romania will be able to obtain. The scenario suggests however that a persuasive case may be made to international lenders that a strategy for growth and development is in place and that a medium-tern borrowing framework exists which is credible, will underpin the reform program, and is commensurate with the economy's carrying capacity for debt. liii. A variety of scenarios can be developed where stabilization is relaxed and pace of reform is slackened. The results are qualitatively the same in each case, differing only in numerical degree: growth performance is much worse, exports fail to expand to potential, imports are squeezed by a presumed lower financing availability, ani foreign investment flows are muted with negative repercussions upon investment and growth *s.umption continues to fall, with weak medium-term recovery. By the end of decade the economy is m (he unenviable position of having amassed substantial external liabilities, with little real restructuring and diminished prospects for sustained rises in living standards.  xviii liv. The fundamental message is indeed clear: there is no altemative, but to intensify efforts at ensuring the success of the major systemic changes the Govemment has embarked upon. Although few would wish to minimize the difficulties, the economy has considerable potential to overcome the legacy of the past, and to establish itself on a growth path which will entail sustained and rising living standards for the peo;ple of Romania.  This report on the Romanian economy is organized in the following way. Chapter 1 provides an histor.cal overview of the system of central planning and describes macro- economic developments through mia 1991. Chapter 2 provides an overview of sectoral structure, performance and developments. Chapter 3 focusses on the macroeconomic stabilization and systemic reform agendas, outlining the significant progress to date, while providing recommendations on the future evolution of these programs. Chapter 4 summarizes the progress in sectoral reform while, again, identifying areas in which further efforts are advised. Finally, Chapter 5 discusses the medium term outlook for the economy. Volume /I of the Report discusses in greater detail, sectoral developments in the following sectors: the financial sector, energy, industry, agriculture, and infrastructure; the industry chapter, in particular, contains a discussion of privatization and restructuring strategies. The Social Sectors are the subject of another report, which has already been submitted to the Romanian Government. In addition, extensive sets of working papers on agriculture and industry are being made available to the government. Volume 1/1 contains a basic set of statistical data.  CHAPTER 1 ECONOMIC STRUCTURE AND DEVELOPMENTS 1. INTRODUCTION 1.1 Romania is one of the largest of the former centrally planned economies in the Central and East European Region with a land area (237 thousand square kilometers) and population (23 million) equivalent to Yugoslavia and second only to Poland. It was formed in 1859 of the principalities of Wallachia and Moldavia; Transylvania was added in 1918. The country has a wide range of natural resources. About 60 percent of its area is suitable for agriculture, with climatic and relief characteristics favoring both arable and pastoral farming. The Danubian plains contain a variety of fertile soils, permitting the irrigated cultivation of cereals including wheat, barley, and maize; sunflower, sugar beet, and a variety of vegetables and food crops are also grown. Vineyards and orchards are found in upland areas, and pastoral farming takes place wherever grazing is available. Long a major food producer, Romania was a net exporter of agricultural and food products until the early 1980s. Some 27 percent of the country, chiefly in the Alps, is forested, providing the basis for an important industry and stimulating a distinguished tradition of furniture making. The agrarian roots of the economy persist as, until recently, over half the population lived in rural areas. Romania has significant resources of fossil fuels-oil, natural gas, coal and lignite-although continuous exploitation of oil and gas has led to the prospect of exhaustion of known reserves witfin a decade. Scattered deposits of ferrous and nonferrous minerals are found throughout the country. 1.2 During most of its modern history, Romania has been a monarchy. In the interwar years, a number of parliamentary coalition Governments ruled the country, although the decade of the 1930s is traditionally regarded as a period of strong monarchial rule. In 1948, after several years of consolidating power, the Communist Party secured the King's abdication and installed Petru Groza as Head of Government. The Communist leadership nationalized mining, banking, insurance, transportation, and the principal industries. Central planning wa- introduced, and a drive begun to collectivize agriculture. Groza was succeeded in 1952 by Gheorghe Gheorgiu-Dej, who was succeeded in 1965 by Nicolae Ceausescu. 1.3 The early years of Ceausescu's rule were marked by distancing the country, economically and diplomatically, from the Soviet Union,1' a growing rapprochement with the West, and a cultivation 1/ Romanian mistrust of the Soviet Union has strong historical roots. Over the centuries, the principalities of Wallachia and Moldavia were invaded fourteen times from the East. In 1940, Carol was foced to cede Bassarabia and Bukovina to Stalin. In the words of one historian 'No other part of Eastem Europe, except what was to become the GDR, was robbed more cynically or systematically by the Soviet Union in the post-war years.' (I.F. Brown: Conservatism in the Balkans, Westview Press, 1989.)  2 of ties with developing countries. In 1967, in the first major break with Soviet-coordinated Western policy, Romania established diplomatic relations with the Federal Republic of Germany. This was followed in 1968 by round condemnation of the invasion of Czechoslovakia. Visits by several Western leaders to Romania followed. Romania became member of the World Bank and the International Monetary Fund in 1972 and the United State granted it Most Favored Nation (MFN) trade status in 1975. The growing ties with the West opened the gates to increasing supplies of Western exports and credits, helping the country achieve the highest growth rate of any CMEA country in the 1970s. 1.4 Ceausescu's authorita.ianism, compounded with unprecedented nepotism and a personality cult angered and huumiliated most Romnanians. Socially and economically, the later Ceausescu years were a tragedy for Rornania. An ill-conceived population policy caused great damage to the fabric of family life and resulted in very high rates of maternal and infant mortality. Public funds were diverted on a massive scale to build huge showca-e projects. In the late 1980s, a 'village systematization' project, designed to herd some 7,000 village communities into monolithic urban centers, was started. The industrialization drive continued with immense misallocation of investment resources. Most particularly, a decision to repay the $13 billion foreign debt starved the economy of modern technologies and contacts with the outside world and led to extreme hardships for the population. The last decade has left an inheritance of a devastated economy--one which will take years to repair and rebuild. 1.5 In December 1989, Ceausescu was ousted and executed. A provisional government ruled Romania until May 1990, when the National Salvation Front won an open election and established a coalition government with Ion Iliescu as President. Petre Roman serves as Prime Minister in the Government, which has seen as its principal task the remaking of Romania as a market economy. The main elements of the government's program are: (i) dismantling the command structures of the economy; (ii) a privatization program in which 30 percent of assets in state enterprises are to be distributed free to the population; (iii) establishment of a two-tier banking system; (iv) a major land reform in which agricultural land is to be largely privatized; and, (v) a gradual process of price liberalization accompanied by macro-stabilization. In this chapter an overview of the functioning and dismantling of the centrally planned system is provided, as well as an examination of price liberalization and stabilization. An analysis of the other elements of systemic reform is contained in Chapter 3, while sectoral developments and requisite reforms are analyzed in Chapters 2 and 4. II. THE CENTRALLY PLANNED ECONOMIC SYSTEM 1.6 Romania's postwar system of central planning contained features similar to those in other socialized economies. Annual plans were developed by the State Planning Agency, largely based on physical output targets. Once approved, plans were implemented through branch Ministries, each covering a sector. Material balances, formulated in the process of plan preparation, attempted to ensure the  3 consistency of input supplies with physical output targets. The plan prescribed the distribution of supplies among alternative uses as well as to branch Ministries. Consumer goods were allocated by district. 1.7 Prices were strictly regulated and did not play an allocative role. For long periods, consumer and producer prices were relatively stable and were kept insulated from changing world prices by explicit and implicit multiple exchange rates and through the operation of price equalization funds. Major world price realignments after the second oil shock in 1979 did, however, force domestic price changes in 1981-83, a unification of the various commercial exchange rates, and a depreciation against the dollar. These measures, taken to provide exporters with incentives to export, were partially rolled back in 1984. Enterprise wage bills and the wage structures of state-owned enterprises were also centrally determined, as were the number of enterprise employees; managers had virtually no control over these parameters. 1.8 As in other socialist countries, the physical plan provided the basis for the financial plan that regulated intersectoral financial flows. The financial system, comprising a Central Bank and a few specialized financial institutions, provided credit to fulfill plan targets. Enterprise investment was largely 'financed' through transfers from the budget, itself an instrument for resource redistribution. Foreign trade was similarly controlled and was managed exclusively by specialized foreign trade organizations (FTOs), under thte supervision of the branch Ministries. 1.9 Two important reforms to this basic structure were attempted in the late 1960s and 1970s. In 1968, to improve the realism of plan formulation and enhance coordination and plan fulfillment, 200 centrales were created, covering all enterprises in mining, industry and construction. These units combined enterprises conducting similar activities within particular geographical areas; average employment in a central was 8,000, although some centrales were as large as 100,000 employees. Draft plan formulation was intended, in these reforms, to commence at enterprise level, and the centrales were the recipients of plan targets, indicators, and material supplies, which, in turn, they distributed to enterprises. These attempts at decentralization were not successful. Although a number of directorates in the Planning Ministry were abolished, central planning, following Communist Party directives, remained the universal instrument of targets and coordination, and enterprises lost further power over decisions to the centrales. Nonetheless, the centrales did become powerful institutions of enterprise organization (see Industry Section in Chapter 2). 1.10 In 1979, 'New Economic Measures' were instituted, intended to enhance the scope for enterprise autonomy by sharpening the rewards and penalties for enterprise performance. In particular, more precise measures for enterprise output were introduced, forward contracting to ensure plan fulfiUlment was encouraged, links were forged between labor remuneration and plan fulfillment, and self-financing of investment expenditures was fostered. These measures, again, did not succeed; for all practical purposes, economic activity continued to be directed from the center and, during the 1980s in particular, were heavily driven by political decisions. Indeed, as these measures focused on penalties rather than rewards,  4 they contributed to increased enterprise falsification of data--overstating gross output and stocks of finished products and understating inventories of internediate goods--in order to enlarge reported profits. 1.11 In contrast to Poland and Hungary, whose initial reforms increased enterprise autonomy and liberalized prices under socialized planning, Romania's efforts to reform and decentralize decision-making achieved relatively little. Today's transition to a market economy thus has fewer foundations and traditions of continuity to build upon and must be considered all the more difficult. 1.12 Following the December 1989 revolution, the Planning Office was disbanded early in 1990 and replaced initially by a Ministry of National Economy, itself in turn replaced by a Ministry of Resources and Industry. Early in 1991, economic management was vested in a single Ministry-the Minist.y of Finance and Economy--headed by a Deputy Prime Minister. The monopolies of the Foreign Trade Organizations was ended, and enterprises and other agents allowed to enter into contracts with organizations of their choice. The functions of the centrales--a series of very large enterprise holding groups, which co-ordinated and implemented Plan decisions--were abolished, and greater autonomy given to enterprise managers; strict regulative planning gave way to indicative planning with greater reliance on enterprises seeking their own sources of supply and producing outputs they can sell profitably. Material balances continued to be drawn up for a number of key products and public enterprises, however, and efforts, albeit not transparent, were made to ensure that certain enterprises received necessary materials. At the same time, prices of key inputs and of basic consumer products remained controlled. The system in place in 1990 could therefore be characterized as a mixed system of indicative targeting, material distribution and partial price control, coexisting with greater enterprise autonomy and a dilution of economic direction in the state sector and a modestly growing private sector (particularly in agriculture and trade). This mixture of a command and market systems did not work smoothly. It imparted considerable uncertainty at the enterprise level and significantly affected production and trade. This transitional state and its further evolution, where greater price liberalization and enterprise autonomy haveo occurred, is discussed in detail in the following chapters of the report. Ill. DEMOGRAPHY AND SOCIAL DEVELOPMENTS A. Population Developments 1.13 The crude birth rate (CBR) averaged 22.2 per thousand in the late 1950s, but by 1965, it had fallen to 14.6-the lowest rate in Europe. The low rate has been attributed to (i) the 'echo' effect of the decline in fertility during WWII, (ii) increased female participation rates, and (iii) the scarcity of housing. Alarmed by this rapid decrease, the Ceausescu Government adopted a radical and harsh demographic policy in 1966 that outlawed birth control completely and abortion except in the most extreme circumstances while imposing strong penalties on those who disobeyed the policy. At the same time, generous and progressively increasiag family allowances were instituted. The immediate result was a sharp  S rise in the birth rate in 1967, from 14.3 to 27.4 per thousand population, apparently due almost entirely to the non-availability of abortion. After 1967, however, illegal abortions increased, and the CBR again began to fall; by 1983, the birth rate reached 14.3/1,000. The total fertility rate (roughly, the number of children women can expect to bear, on average, during their reproductive lifetime) stands at 2.1, exactly the replacement level.l' 1.14 One of the first steps the Govermnent took after the 1989 revolution was the re- legalization of abortion. Despite an initial resistance among women to come to state health facilities for abortions, almost I mnillion abortions were performed in 1990 (3 abortions for each live birth). The legalization of abortion cauF?d deaths by abortion to fall by 75 percent, reducing the tragic levels of maternal mortality under the Ceticsescu regime. 1.15 The crude death rate in Romnania had fallen to around 10 per thousand by the mid-1950s and dipped to as low as 8.1 in 1964. Thereafter it rose (to 10.7 in 1989 and 1990), in part as a consequence of the severe abortion policy, which increased maternal mortality, in part because of a general aging of the population that normally accompanies a prolonged period of low fertility, and in part because of policies in the later Ceausescu period that sacrificed domestic consumption to exports. In 1989, Romania had an estimated rate of natural increase of 0.45 percent per year, which dropped to 0.29 percent in 1990, comparable to other Eastern European countries and the lowest in Romania's history. B. Social Indicators 1.16 Romaniahas made significantprogress in the developmentof human resources. Although its indicators are among the lowest in Europe, Romania is also one of the poorest countries in this region, and, when compared with other countries at its income level, it is well above average. Only Chile, one of the best performers in Latin America, does better than Romania on the broad health outcome indicators (life expectancy and infant mortality). Among the comparator countries outside of Europe, however, Romania has been an outlier on maternal mortality owing to its harsh population policy (Table 1.1). As noted, this rate fell by two-thirds in 1990, with the availability of legal and safe abortion. Despite a relatively low expenditure on health, Romania has created a substantial health infrastructure as measured by facilities and staff, although the quality of facilities is deteriorating. It is also well above its comparators outside the region with respect to educational attainment of the population despite higher pupil- 1/ This is especially remarkable in view of the fact that marriage is nearly universa and that the average age of women when they bear their first child has remained virtually unchanged over the past 50 years. In other words, unlike most of the rest of the world, where delayed marriage and delayed first births account for much of the fertility decline of the past 20 to 30 years, in Romania, nearly all fertility decline has occurred within marriage.  6 teacher ratios. Higher education is, however, disproportionately concentrated in science and engineering, leaving Romania short of skills in the social sciences, business, and the humanities. Table 1.1: COMPARATOR TABLE Middle South Income Korea Argentina Chile Malaysia Poland Yugeslavia Romania Awage Population (million), 1988 42.4 31.5 12.8 16.9 37.9 23.6 23.1 GNP per capita (USS), 1988 a/ 3,530 2,6&,O 1,510 1,870 1,850 2,680 1,620 h/ 1,970 HIEALTH Crude Birth Rate (per 1,000 pop.) 28.5 21.2 22.0 30.9 16.1 15.3 16.0 28.7 Infant Mortality-1987 c/ 33.0 32.0 18.6 24.0 18.0 25.4 25.6 55.0 Life Expectancy at Birth (years) 70.0 70.6 71.0 69.5 71.4 71.3 70.0 66.4 Health Expenditures/GDP-1984 d/ n/a n/a n/a 5.2 4.5 2.3 n/a Population per: Physician 1,155 374 1,231 1,935 487 549 554 933 Hospital Bed 596 n/a 391 400 n/a n/a 112 n/a Maternal Mortality et n/a 69 46 59 11 22 150 n/a EDUCATION Gross Enrollment Ratios Primary (% school-age group) 104 109 109 101 101 95 95 100+ Secondary (% school-age group) 89 74 70 54 80 82 85 48 Pupil-Teacher Ratio: Primary 36 20 33 22 16 24 21 26 Secondary 33 8 n/a 26 12 n/a 37 n/a Illiteracy Rate-1985 (% pop. age 15+) n/a 4.5 5.6 26.6 n/a 8.8 n/a 16 LABOR FORCE Total Labor Force (millions) 18.3 11.3 4.7 6.7 19.5 10.7 10.9 % in Agriculture n/a 13 n/a 42 19 n/a 27.9 % in Industry n/a 34 n/a 19 42 n/a 8.1 .. Participation Rate f/: Overall 45.2 35.3 36.2 40.4 51.4 45.4 47.2 35 Female 41.2 19.5 20.3 28.5 45.7 34.7 42.1 18 Source: Social Indicators of Development, 1989 1990 World Population Data Sheet Romania 1989: Ministry of Health, Education, and National Commission of Statistics at GNP per capita calculated by World Bank Atlas Method. b/ Romania's GNP per capita in 1990, calculated at the average official commercial exchange rate. _/ Infant deaths per 1,000 live births. A/ Share of health expenditures in GDP for Poland, Yugoslavia: Tymowska, 1986, p.2. g/ UNICEP, State of the World's Children, 1991 (1989 data). f/ Percentage of population of all ages in the labor force.  7 C. Health 1.17 Ronania's progress in improving the health status of the population virtually halted about 1985, and the significant gains identified above are in danger of being eroded. The main reasons appear to be (i) poor socio-economic conditions; (ii) linited preventive health programs combined with a high prevalence of risk factors such as cigarette smoking, a high cholesterol diet, and environmental pollution; (iii) a poorly equipped and supplied health care system, which is often unable to intervene effectively in health crises; and (iv) the lack of an effective family planning program. 1.18 Health care services in Romania are almost exclusively organized, provided and financed by the Govermment. National expenditures on health are low in Ronania, although, if inputs were valued at their un-subsidized opportcnity cost, the figure would be well above the estimated 3.3 percent of GDP spent in 1989. All citizens are guaranteed access to health care free of charge. 1.19 The system of allocating resources (financial, physical, and human) is highly centralized and rigid. The basic administrative unit for activities in the health field is the distiict (judet). Patients typically enter the system through the primary health care facilities; for more serious conditions, patients are referred to secondary and tertiary facilities (polyclinics and hospitals.). In the past few years, shortages of materials and supplies at the primary level has pushed patients up to higher levels of health provision than would be necessary if the primary facilities were well stocked. Even so, Romania appears to have an adequate quantity of buildings and staff in the health sector, as hospitals are under-utilized and the population per doctor is high given Romania's income. But the quality of the facilities is deteriorating due to the shortage of fumds for maintenance; and the personnel, especially at the technical level (nurses and lab technicians), are inadequately trained. Romania's isolation during the 1980s has left the medical personnel with an important knowledge gap to fill. D. Education 1.20 The Romanian education system is well organized and serves the population quite equitably. Schooling is free and universal through age 14, attendance is high, and dropout rates low. Buildings are we1l maintained, and teachers are well-qualified. While Romania's population has a high level of school attendance relative to other countries at its income level, no data are available on the educational attainments of the population nor have Romanian students been tested on standardized intemational achievement tests. Thus, the effectiveness of Romania's education system compared with other countries remains unknown. 1.21 Education in Romania is organized and financed by the Government. Following the revolution, the Ministry of Education and Science (MOES) was restructured, and the educational system is being reformed. However, the administration is still hierarchically organized under fairly rigid central  8 control. The MOES has overall responsibility for all preschool, primary, secondary, and higher education and training and for scientific research and development. 1.22 The education system provides programs for all age groups: children beginning age 3 through 'in-service' training for adults. 82 percent of children age 3 to 6 are in preschool programs. Children aged 7 to 15 are in elenentary school programs, with a standard curriculum prescribed by the MORS. Romanian secondary education has always been heavily directed towards vocational training, with academic secondary school places reserved for a small elite. As the Romanian economy developed in the post-war period, secondary education became even more vocationally oriented, as the goal of the system was to "serve the needs of enterprises". The specialization of programs also increased, and most training was physically located on or near the grounds of an enterprise. By 1989, only 65,000 students, 4 percent of enrollment, were enrolled in academic secondary schools. In 19W0, public higher education had an enrollment of about 165,000 students. With an enrollment ratio of 10 percent, Romania has the lowest number of 20- to 24-year-olds in higher education in Central and Eastern Europe. (In recent years there have been sixty applicants for each place.) Sixty percent of university students study technical or engineering subjects. Higher education and training have expanded significantly since the revolution, and pressures will be high to continue to expand throughout the 1990s. Most prestigious is the system of 44 public universities and institutes. Since the revolution, a number of private universities have also sprung Up. 1.23 The challenges faced by the educational system, as Romania moves towards a market economy, are many. They include reforming the management and finance of education, widening secondary school programs and opening greater options for students, expanding higher education, cirriculum reform, and overcoming the handicap of years of isolation from modem pedagogical methods. These issues are treated in Chapter 4. E. The Social Benefits System 1.24 At present, Ronania provides four main types of social benefit. (i) Unemployment benefits and related benefits are the subject of a new law. The benefits are funded out of a new contribution and will be separate from the main social insurance benefits. (ii) Social insurance benefits are funded (at least notionally) out of social insurance contributions. The major benefits are: sickness benefits, maternity benefits, and pensions for retirement, disability, and widowhood. (iii) Family benefits, (mainly child allowance), are funded out of the general government budget.  9 (iv) Social assistance (i.e. 'welfare"), also funded out of the central government budget, concentrates mainly on benefits for the handicapped, with some (mainly in-kind) . ~nsfers to other poor people. The coverage and provisions of each of these for benefits are summarized in Annex 2. Under the system of central planning, the system served multiple purposes, including (i) redistributing incomes; (ii) providing insurnce against loss of income from accident, sickness and the like; (iii) preventing poverty; and (iv) encouraging population growth. To date, the system has been reasonably successful in providing a minimum level of social insurance. It does not appear to have fully alleviated poverty, and it has not been successful in encouraging population growth (nor is it likely to in the future). 1.25 The social benefits system is administratively complex, as there are, for example, over ten separate pension funds (regular state employee, supplementary, agricultural cooperative, non- agricultural cooperative, etc.). Under the system of central planning, aliocation of resources on the basis of economic efficiency was not a goal. It will, however, need to be an important goal during the transition to the market economy as the system has some important weaknesses (see Chapter 4).  10 IV. THE MACROECONOMY Box 1: Statistics in Romania Since the revolution, access to all Romanian data has been commendably open and free. At the same time, it is admitted that considerable falsification of data occurred during the later Ceausescu years. Perhaps the most egregious examples of this occurred in the reporting of production in agriculture where, for instance, reported output of cereals was sometimes three times as high as the recorded actuals. Romanian statisticians are now engaged in the task of reconstructing accounts to obtain a more accurate picture of what actually occurred. In the first instance, this effort is devoted to reconstructing the national income accounts. These have been revised for the period 1987-89, and partially revisd for the period 1985-86; it is believed that misrepresentations prior to 1985 were not quite so severe as occurred in the latter half of the decade. Even so, it must be noted that many aspects of statistical methodology in Romania make analysis of treds, as well as comparisons with other countries, difficult, particularly with respect to prices, imputations of product quality change, net value of output, and foreign trade. Moreover, some aspects of reporting-as, for instance, the use of a moving price base for computing real changes in activity--make the Romanian system unique, even in the socialist world. (These inadequate data have contributed to exaggerated growth figures.) In this report, every attempt has been made to bear in mind these data deficiencies and idiosyncracies. The historical record has been evaluated primarily with reference to broad trends and by reference to qualitative judgements made by other knowledgeable analysts. As a result of the tremendous effort of the Romanian Statistical Commission, it is believed that data covering the last two or three years are reasonably accurate. 1.26 The fundamental feature of Romanian development strategy since the 1950s has been rapid industrialization of an initially agrarian economy through high rates of investment and through use of domestic energy. Industry overtook agriculture as the largest contributor to national output in the early 1950s, although it took until the mid-1970s before the work force in industry overtook that in agriculture (see Chart 1.1). As a result of policy and because a number of service functions are internalized within enterprises, the officially measured services sector has remained relatively small. In 1989, industry contributed 53 percent to GDP. The share of industrial output in total value added is considerably higher than in other middle income economies where, on average, industry contributes 40 percent of GDP.!' The proportion is, however, similar to other reforming socialist economies; in Bulgaria and Czechoslovakia, industry's contribution is between 55 and 60 percent. In 1989, Romanian agriculture contributed 14 percent to output.Y j/ World Development Report (WDR): IbRD, 1990 Z/ In 1990, due to large drop in industrial output and a rise in that of agriculture, the share of industry in GDP fell to 48 percent and that of agriculture rose to 18 percent.  11 Chart 101 Distribution of Economic Activity 1965 & 1989 100% 75% _ .ndu.try Agriculture 50% / [Z- Construction Transport & Comm. 25% -Trade & Services 0% 1965 1989 Industry 45.1% 52.9% Agriculture 26.7% 13.9% Construction 8.1% 6.3% Transport & Comm. 5.8% 7.5% Trade & Services 14.3% 19.4% Distribution of Work Force 1965 & 1989 100% mIndustry 76% - Aoriculture construction 50% l Transport & Comm. Other Services 26%- - 0% 1966 1989 Industry 19.2% 38.1% Agriculture 56.6% 27.6% Construction 6.3% 7.1% Transport & Comm. 3.7% 6.9% Other Services 14.3% 20.6%  12 A. Growth 1.27 The overall growth performance of the economy and of its individual components is difficult to establish because of data falsification. The 1950s appear, nonetheless, a period of relatively moderate growth; through the 1960s and 1970s very rapid growth of national product was reported, averaging between 7 and 9 percent p.a., with industrial growth rates of 10 to 11 percent p.a. and agricultural growth much slower, 2 to 3 percent p.a. Table 1.2: GDP AND PRODUCTION GROFTH (% change p.a.) 1978-81 1982-85 1986-89 1985 1986 1987 1988 1989 1990 GDP 4.5 4.0 -0.8 -0.1 2.3 0.8 -0.5 -5.8 -7.4 Industry (& mining & util.) 7.8 4.6 -0.4 -2.4 4.2 0.9 -3.2 -5.3 -16.6 Agriculture & Forestry -6.0 3.1 -3.4 1.3 -7.0 -9.7 9.1 -5.9 10.4 Construction -1.5 5.5 -3.7 5.3 2.5 -0.9 -0.7 -15.9 -9.5 Transport & Comm. n.a 4.7 1.8 2.8 1.7 1.6 5.3 -1.5 -10.2 Trade & Services, nie 7.9 2.7 0.4 3.6 -0.3 8.3 -1.2 -5.2 7.0 GDP: NOMINAL AND CONSTANT VALUES 1975 1980 1985 1986 1987 1988 1989 1990 Current Price GDP (in bin. Lei) 427.0 616.9 817.4 838.6 845.1 857.0 798.0 844.0 GDP (in bin. $) / 21.9 34.3 47.7 51.9 58.1 60.0 53.5 37.6 Constant Price h/ GDP (in bin. Lei) 432.9 616.9 720.2 736.7 742.6 738.9 696.1 644.6 Sources: National Statistical Commission, Ministry of Finance, and staff estimates / Converted at the average exchange rate for the year k/ Estimated, at 1981 prices. 1.28 By the end of the 1970s, however, emphasis on rapid industrialization and high investment, coupled with the attempt to insulate the economy from extemal prices, had led to heavy import dependance, particularly on oil and raw materials. Deteriorating terms of trade, unaccompanied by improvements in exports to convertible currency markets, led to widening trade and current account deficits (Chart 1.4) and increased reliance on foreign borrowing. Despite some corrective steps supported by an IMF Standby, the country was subjected to a sudden withdrawal of short-term foreign credits in 1981. This event had a wrenching effect on the Romanian economy and negative effects on growth. It led to policies of reducing  13 external dependence through lower imports and a proscription on new foreign borrowing, culminating in the decision to repay the foreign debt. 1.29 Between 1980 and 1987, reported output increased by 4.7 percent p.a. As noted earlier, there are serious difficulties in accepting these estimates. A correction for hidden inflation, of 3 to 4 percent p.a., indicates much lower growth, perhaps 1 percent p.a. In 1988 and 1989, for which corrected growth figures are available, GDP fell by 0.5 percent and 5.8 percent respectively, with the largest declines occurring in industry and construction. Most probably, Romania 's output per capita in 1989 was below its lekv in 1980. 1.30 Several factors explain the loss of dynamism and eventual negative growth through the 1980s. First, the production-mix of industry, slanted toward heavy goods and chernicals, failed to provide the basis for domestic expansion. Second, export-led growth also proved to be a failure, as exports declined in nominal and real terms from 1983 on. Third, associated with, and partly contributing to, the decline in exports was the severe compression of imports engineered to repay the foreign debt; this created shortages of raw materials and permitted virtually no technological upgrading. Fourth, investment funds were misallocated by expanding capacity in existing industries rather than building capacity in more dynamic sectors, particularly consumer goods. In addition, investment funds were channeled to large, .iproductive 'showcase' projects. Fifth, agriculture was relatively neglected and, in the later vears of the decade, suffered from prolonged drought. Sixth, domestic energy production experiencem ular falls in output. Finally, attempts to decentralize decision making and to provide greater incentives for achieving targets through increased efficiency at the enterprise and farm levels did not take hold. 1.31 In 1990, GDP dropped by a further 7.4 percent, resulting anainly from a 16.6 percent in industrial output and a 10 percent decline in construction and transport; these were partly offset by a 10 percent growth in agriculture and a 7 percent growth in setvices. The large drop in industrial output is attributable to the disruptions caused by the December 1989 revolution, by shortened work week (abolishing weekend work), increased absenteeism and reduced production for expo-s the ,.MEA countries, particularly the USSR, of machinery, chemicals and petroleum products. The strong rise in agricultural output seems to be essentially the result of a jump in the production of meat and meat products (including reduction in livestock), which was stimulated by imports of large quantities of animal feed and by a reduction in herd size. B. Domestic Investment and Consumpt.on 1.32 Fixed investment in Romania grew rapidly through the 1960s and 1970s, peaking at 35 percent of GDP in 1980 (Table 1.3). It remained at *he relatively high level of about 30 percent in the 1980s, before suffering a real decline of some 38 percent in 1990. Through most of the last three decades, the emphasis has been on industrial investment, which has averaged 45 to 52 percent of total investment; within  14 industry, the emphasis has been on producer goods industries, which absorbed 85 to 92 percent of annual investment to the industrial sector. The energy, chemnicals, and machine building sectors were particular beneficiaries. As part of a deliberate effort to quicken industrialization, investment in agriculture declined sharply in the 1970s but has since returned to earlier levels of 16 to 18 percent of total fixed investment. All but 2 percent of investment was by the public sector. Three quarters of public sector investments were in state enterprises and cooperatives and about a quarter was spent by the central and local governments on defense. housing and the social sectors (Table 5.8 in the Statistical Appendix). 1.33 The investment ratios of the last decade, at 30 percent of GDP were high compared with those in middle-income countries, where they have averaged 25 to 27 percent of GNP in the latter half of the 1980s (WDR 1990). 7he poor growth performance that accompanied this investment effort, however, can only suggest serious misallocation within and across sectors, low technical efficiency of the growing capital stock, and low efficiency in the utilization of capital at the enterprise and plant level. A contributory factor consisted in the switching, through the 1980s, of investment imports from OECD countries to CMEA countries, where outdated technologies and poor quality machinery exacerbated problems of reliability and of achieving enhanced productivity. In addition, substantial, though unquantified, investment resources were allocated to projects with low productivity, including the House of the People, the Danube-Black Sea Canal, and the Bucharest-Danube Canal. 1.34 Private, consumption in Romania has averaged about 54 percent of GNP through most of the 1980s, lower than in other middle income countries, where the average has been about 62 percent (Table 1.3 and WDR 1990). Price distortions and the widely observed phenomrrena of shortages, rationing, queuing, poor quality products, and forced substitution further qualify interpretations of consumption performance. Indeed, examination of comprehensive household budget survey data indicate a consumption pattern quite different from those in other middle income countries (Chart 1.2). In 1989, average expenditures on food approximated 50 percent of Romanian household income, compared with 24 to 38 percent in middle income countries of per capita incomes $1,500-$2100!-' Clothing and footwear expenditures absorbed 13 percent of household expenditures, whereas in the comparator country sample, the maximum expenditure was 10 percent and the average considerably less. With relatively low rents and largely free medical care and education, Romanian households spent less on these items--(8 percent)--than did comparator countries (20 percent). Fuel and energy consumption in the average Romanian budget was 6 percent of expenditures, compared with 2 to 5 percent in other countries. Differences in relative prices, in patterns of subsidization, and in consumption preferences do, of course, make comparisons of this kind difficult to interpret. But the relatively high expenditure ratios on food, clothing and shoes and household fuels, coexisting with known 'shortages' of these items, suggest standards of living lower than indicated through traditional conversions of national income to comparable bases. 1/ WDR 1990; comparator country data were collected through the International Comparisons Project on Living Standards.  15 Table 1.3: INVESTMENT, CONSUMPTION, AND SAVINGS (in percent) 1965 1970 1975 1980 1985 1988 1989 1990 1963 Prices Curren. 9rices rixed Investment (% of GDP) 24.5 27.8 28.4 34.1 30.1 28.1 29.6 20.0 Distribution of Investment (% of total) Industry 51.5 50.8 51.9 50.9 48.4 47.7 43.4 44.2 Producer goods 91.0 84.7 85.2 81.0 84.8 86.6 83.4 80.7 Consumer goods 9.0 15.3 14.8 19.0 15.2 13.4 16.6 19.3 Agriculture 17.3 17.1 11.0 13.3 18.2 16.5 17.3 17.9 Construction 1.0 1.3 0.8 4.6 4.6 4.7 4.7 4.0 Transport and Telecomms. 2.4 3.1 1.8 12.0 10.7 10.0 10.6 10.5 Housing n.a n.a n.a 10.4 8.3 9.2 8.2 10.1 OtherServices 4.2 4.5 7.9 8.3 8.8 11.1 15.4 12.5 Consumption (% of GNP) n.a n.a 57.4 64.4 60.9 62.3 67.8 82.7 Public n.a n.a n.a 7.1 10.0 9.4 9.8 12.6 Private n.a n.a n.a 57.3 50.9 53.0 58.0 70.1 Domestic Savigs (% of GDP) n.a Dn. n.e 37.1 37.3 35.4 31.3 15.0 National Savings (% of GNP) .. .. n.a 33.5 33.9 32.7 30.6 15.8 Source: National Commission of Statistics, Ministry of Finance  16 Chart 1%2 AVERAGE CONSUMPTION BASKET: 1989 Food 60% Clothing & Shoes 13% Energy 7% Housing 8% Transportation 4% Eduo. & Health 3% Other 20% DISTRIBUTION OF WAGES: 1989 Percent of Labour Force in Wage Bracket %of Labour Foroo so 26- 20- 16- 10 6 Avoroge Monthly Lol Earnings Dole oovet v8% ot Labour Foroo  17 1.35 While the low level of consumption in the past decade has been accompanied by a high level of savings, as can be expected, the savings rate was in fact extraordinarily high in the latter part of the decade-- considerably higher than the investment rate (Table 1.3). The excess of up to 7 percentage points of GDP in 1985-88 (down to 1 percent in 1989) represente'l the 'resource surplus' that was syphoned off from the economy to repay the external debt. Tins situation was completely reversed in 1990, following the December 1989 revolution. The savings rate dropped to 15 percent of GDP, compared with a 20 percent investment rate, resulting in a resource deficit of 5 percent of GDP. 1.36 The main reason for the reversal in 1990 was the huge rise in consumption. Constraints on consumption were relaxed, large imports of consumer goods and raw materials for food were allowed and production of food products promoted. Large liquid balances and raised wages early in the year (15- 20 percent in industry) stimulated household consumption. Public consumption rose relatively even more than that of households. The result was a jump in total consumption of over 20 percent in real terns, bringing its share up to 83 percent of (a smaller) GDP. C. Public Finance 1.37 Romania's public finances have traditionally covered many institutions--the central administration, the social insurance funds, the 40 judets (districts), and the local governments of the city of Bucharest, other municipalities, communes, and towns, extra-budgetary flnds, and certain self-financing institutions. 1.38 As in other reforming socialist economies, the tax system has been highly discretionary and differentiated. The main sources of central government revenue has been various taxes and remittances paid by or through the state enterprises (Table 1.4). Remittances of profits by enterprises, replaced by a tax on profits in 1990, were at rates usually set anew every year, based on planned revenue needs. The turnover tax (on consumer goods sold by State enterprises) and the tax on net production (on a value-added- related measure until 1986, then on a profits measure) have been the main direct taxes on enterprises. Together with the tax on wages (the remuneration fund) and social insurance contributions, which are paid through the enterprises, these revenue sources accounted for about 90 percent of government revenue during 1985-90. 1.39 Expenditures during 1985-89 were concentrated on capital expenditures (ranging from 35 to 40 percent of spending) and on subsidies and transfers (ranging from 17 to 25 percent of the total). These included mainly state pensions and state allocations for children, but also included subsidies to public enterprises. Subsidy amounts reported in the budget are, however, afraction of actual subsidies, as these enterprises accumulated huge unserviceable debts to the banking system. Available data indicates that the bulk of such subsidies and accumulated debts have been for agricultura: