BULGARIA: INVESTMENT CLIMATE ASSESSMENT VOL. 2

BULGAR I A Investment Climate Assessment (In Three Volumes)

Volume II Detailed Report Finance and Private Sector Development Department Europe and Central Asia Region

October, 2008 Document of the World Bank

Report No. 45819-BG

Washington, DC

Copyright © 2008 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, N.W. Washington D.C.20433, U.S.A. All rights reserved Manufactured in the Republic of Bulgaria First printing: October, 2008 Report No.45819-BG This volume is a product of the staff of the International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed in this paper do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. In case of any discrepancies, the English language of the report “Bulgaria: Investment Climate Assessment” will govern.

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ISBN: 978-954-91029-4-9

ii

Currency and Equivalent Units (Exchange rate effective October 28, 2008) Currency Unit=Bulgarian Leva (BGN) EUR 1=1.95583 US $ 1= 1.57 BGN

Fiscal Year: 1 January - 31 December

Weights and Measures: Metric system

Abbreviations and Acronyms 2SLS ARCS BAS BIS BEEPS BIM BNB BSE BSMEPA BVQI CBA CEE CEG CEN CENELEC CIP CIS4 CoM DDP EA BAS EA CT EA EBRD ECA EMC EP ESBCB ESF ETSI EU EUR FDI FIAS FP7 FSAP FSC GCGF GDP GIS HKPC HLFS ICA IFIs IFRS IME IMF IP IPR IRC IRCA IRDI ISO IT ITRI

Two-Stage Least Squares Administrative and Regulatory Cost Survey Bulgarian Academy of Sciences Bulgarian Institute of Standardization European Bank for Reconstruction and Development-World Bank Business Environment and Enterprise Performance Survey Bulgarian Institute of Metrology Bulgarian National Bank Bulgarian Stock Exchange Bulgarian Small and Medium-sized Enterprise Promotion Agency Bureau Veritas Certification Currency Board Arrangement Central and Eastern Europe Council for Economic Growth European Committee for Standardization European Committee for Electrotechnical Standardization Competitiveness and Innovation Framework Program Community Innovation Survey Council of Ministers Detailed Development Plan Bulgarian Accreditation Service Executive Agency for Certification and Testing Employment Agency European Bank for Reconstruction and Development Europe and Central Asia Electro-Magnetic Compatibility Employment Promotion Experian-Scorex Bulgarian Credit Bureau European Social Fund European Telecommunications Standards Institute European Union Euro (currency) Foreign Direct Investment Foreign Investment Advisory Service Seventh Framework Program for Research and Technological Development Financial Sector Assessment Program Financial Supervision Commission Global Corporate Governance Forum Gross Domestic Product Gesellschaft f端r Innovation und Unterst端tzung Hong Kong Productivity Council Household Labor Force Survey Investment Climate Assessment International Financial Institutions International Financial Reporting Standards Institute for Market Economics International Monetary Fund Intellectual Property Intellectual Property Rights Innovation Relay Center International Register of Certificated Auditors Industrial Research and Development Institute International Organization for Standardization Information Technology Industrial Technology Research Institute

iii

JPEIR JSC KIST LAD LARACEA LEP LFS LLL LPOS LRQA LSP M&E MES MLSP MoEE MRDPW NACE NATO NAVET NGO NIF NIS NMI NRA NRSD NSF NSI NVSS NWO OECD OLS OP PAL Ph.D. PHARE PISA PPP R&D REER RIA RIPCPH ROSC RTI RTO RVMS SAMTS SG SINTEF SMEs STA TE TFP UK US USAID VAT VC VET WB

Judicial Public Expenditure and Institutional Review Joint-Stock Companies Korea Institute of Science and Technology Least Absolute Deviations Limiting Administrative Regulation and Control on Economic Activities Law Law for Employment Promotion Labor Force Survey Life Long Learning Law on Public Offering of Securities Lloyd’s Register Quality Assurance Law on Spatial Planning Monitoring and Evaluation Ministry of Education and Science Ministry of Labor and Social Policy Ministry of Economy and Energy Ministry of Regional Development and Public Works Classification of Economic Activities (European Union) North Atlantic Treaty Organization National Agency for Vocational Education and Training Non Governmental Organization National Innovation Fund National Innovation Strategy National Metrology Institute National Revenue Agency National Strategy for Research and Development for the Period 2005-13 National Science Fund National Statistical Institute National Veterinary and Sanitary Service Netherlands Organization for Scientific Research Organization for Economic Co-operation and Development Ordinary Least Squares Operational Programs Programmatic Adjustment Loan Doctor of Philosophy Poland and Hungary: Assistance for Economic Restructuring Program for International Student Assessment Purchasing Power Parity Research and Development Real Effective Exchange Rate Regulatory Impact Assessment Regional Inspection for Preservation and Control of Public Health Report on the Observance of Standards and Codes Research and Technology Institute Research and Technology Organization Regional Veterinary and Medical Service State Agency for Metrology and Technical Surveillance State Gazette Foundation for Scientific and Industrial Research Small and Medium-sized Enterprises State Tourism Agency Technical Efficiency Total Factor Productivity United Kingdom United States United States Agency for International Development Value Added Tax Venture Capital Vocational Education and Training World Bank

Vice President: Country Director: Sector Director: Sector Manager: Task Team Leader:

Shigeo Katsu, ECAVP Orsalia Kalantzopoulos, ECCU5 Fernando Montes-Negret, ECSPF Lalit Raina, ECSPF George R. Clarke, ECSPF iv

Table of Contents Acknowledgements Chapter 1: Introduction ��������������������������������������������������������������������������������������1 I. Macroeconomic Background

1

II. The Informal Sector

8

III. The Enterprise Survey

11

Chapter 2: Firm Productivity ������������������������������������������������������������������������� 13 I. Labor Productivity

13

II. Labor Costs

15

III. Technical Efficiency

15

Chapter 3: Innovation & Technology Absorption ����������������������� 21 I. Coordination of the Bulgarian National Innovation System

21

II. Performance of the National Innovation System

23

III. Innovation and Technology Absorption Activities

25

IV. Adoption of Foreign Technology

31

V. Financial Resources for Innovation and Technology Absorption

33

VI. Soft and Hard Infrastructure for Innovation Knowledge Transfer

39

Chapter 4: Standards and Quality ������������������������������������������������������������� 51 I. Introduction

51

II. Standards, Productivity and Growth

51

III. The Bulgarian National Quality Infrastructure

52

IV. Conformity Assessment

55

V. Accreditation

60

VI. Metrology

66

VII. Standardization

71

Chapter 5: Perceptions about the Investment Climate ����������� 77 I. Perceptions about Constraints to Enterprise Operations and Growth

77

II. Main perceived constraints

78

III. Differences in perceptions between different types of firm

80

IV. Comparisons with results from previous surveys

84

V. Summary

90

Chapter 6: Regulation and Taxation ������������������������������������������������������� 93 I. Regulation

94

II. Access to Land

108

III. Courts and Crime

113

IV. Taxation

116

Chapter 7: Labor Markets �������������������������������������������������������������������������������� 121 I. Employment and Unemployment in Bulgaria

121

II. Workers Skills

124

III. Labor regulation

127

IV. Labor flexibility

130

V. Summary and Policy recommendations

132

Chapter 8: Access to Finance ������������������������������������������������������������������������ 137 I. The Financial Sector in Bulgaria

137

II. Perceptions about Access to Finance

140

III. Objective Indicators of Access to Credit

141

IV. Investment

146

V. The Institutional Environment

148

VI. Summary and Policy recommendation

151

Summary matrix for Policy recommendations ��������������������������� 155 References ������������������������������������������������������������������������������������������������������������������� 167 Endnotes ���������������������������������������������������������������������������������������������������������������������� 174

vi

List of Figures Figure 1: Although Bulgaria’s growth has been strong, its initial income was lower than other countries, meaning that there was scope for convergence 2 Figure 2: Gross fixed domestic investment has increased significantly in Bulgaria in recent years— although it remains in-line with investment in other recent EU accession countries 3 Figure 3: In 2007, most fixed investment was in the service sector—fixed investment in manufacturing accounted for only about 20 percent of investment 3 Figure 4: There is a negative correlation between wage levels and the share of investment across sectors in Bulgaria 4 Figure 5: Although Bulgaria’s current account deficit is high, several of the recent EU accession countries from Central and Eastern Europe also have high current account deficits in 2006 6 Figure 6: In 2007, most FDI was in real estate, renting and business activities; financial intermediation; and construction 7 Figure 7: Consumer price inflation has been modest—but not low since the beginning of the decade 7 Figure 8: Firms in the IT sector are less likely to compete with informal firms than other firms are

10 Figure 9: Labor productivity is lower in manufacturing in Bulgaria than in other recent EU entrants

14 Figure 10: Labor costs are also lower for manufacturing firms in Bulgaria

15

Figure 11: Technical efficiency is lower in Bulgaria than in the other EU accession countries

16

Figure 12: Innovative firms are more productive in Bulgaria

17

Figure 13: Impact of improving investment climate variables so that they are equal to the best performing countries in the region 18 Figure 14: The Bulgarian manufacturing sector is dominated by low-technology firms

23

Figure 15: Bulgaria has been granted relatively few patents

24

Figure 16: High technology constitutes a low, but growing, share of Bulgaria’s exports

24

Figure 17: Bulgaria is investing too little in R&D to narrow the technology gap with the EU

25

Figure 18: The productive sector accounts for a limited share of R&D expenditures in Bulgaria 26 Figure 19: Bulgaria spends more on R&D for each patent it generates than in most other countries

27 Figure 20: A dearth of researchers in Bulgaria compromises opportunities for technological catchup 27 Figure 21: There are few workers in the private sector devoted to R&D in Bulgaria

28

Figure 22: Bulgarian firms are less innovative than similar firms in other countries

29

Figure 23: Few Bulgarian firms have innovative activities

29

Figure 24: Bulgarian firms are falling behind technologically

30

Figure 25: Bulgaria imports fewer high-technology products than would be predicted by its income level 31 Figure 26: Bulgaria licenses few foreign technologies but is slowly catching-up

32

Figure 27: Few innovative firms receive funding from the central government in Bulgaria

35

Figure 28: Weak enforcement of intellectual property rights hinder innovation in Bulgaria

39

Figure 29: Bulgaria has a relatively low number of graduates in engineering and science

42

Figure 30: There are limited sources of R&D finance and a severe early stage funding gap available to innovative startups in Bulgaria 47 vii

Figure 31: Highly important effects of innovation during 2002-2004 in enterprises with innovative activities 55 Figure 32: Certification rates are increasing rapidly in Bulgaria

55

Figure 33: Bulgaria has more certifications than other EU countries when accounting for the number of enterprises 56 Figure 34: The quality management system certification market is competitive in Bulgaria

57

Figure 35: Bulgaria has a lot of internationally-recognized ISO 9001 auditors

57

Figure 36: Number of national Notified Bodies in selected countries as of June 2007

58

Figure 37: Bulgaria has accredited a high number of testing and inspection bodies, but very few system certification laboratories 60 Figure 38: Bulgaria dedicates comparable resources than other countries when accounting for income level and the amount has been steadily increasing 62 Figure 39: The Bulgaria national accreditation body has an adequate number of staff to handle the current volume of accredited entities 63 Figure 40: Bulgaria has access to a relatively large pool of accreditation assessors

63

Figure 41: The Bulgarian national metrology institute provides relatively few calibration services and only a small share is provided to commercial calibration laboratories 66 Figure 42: The Bulgarian national metrology institute provides few training, technical assistance or consulting services 67 Figure 43: Number of calibration fields offered at national metrology institutes and share of primary standards in the stock of national measurement standards 67 Figure 44: Taking into account Bulgaria’s size, it has an adequate number of internationally recognized calibration and measurement capabilities (CMCs), but too few in chemistry 69 Figure 45: Bulgaria has a large standards catalogue, most of which are regional standards

71

Figure 46: Bulgaria’s national standards body has more financial and human resources than in most other countries 73 Figure 47: Government transfers account for a large share of Bulgaria’s standardization budget 73 Figure 48: Bulgaria is relatively efficient at raising revenues from standardization activities

74

Figure 49: Bulgaria participates in approximately as many ISO committees as other small EU accession countries, but holds no ISO committee secretariats/working group governorships 75 Figure 50: Firms are most likely to be concerned about corruption, instability, competition with informal firms and worker skills and education 78 Figure 51: The top four concerns are the same for the question on the biggest constraint as in the previous question 80 Figure 52: Inadequately educated workers are a particular concern in the IT areas and in some sub-sectors of manufacturing 81 Figure 53: Managers of small firms are more likely to be concerned about access to finance in most countries in Europe and Central Asia 82 Figure 54: Large firms and firms in the IT sector are less concerned about competition with informal firms than other firms are 82 Figure 55: Business registration is a greater concern for firms in the ‘other services’ sector and in some sub-sectors of manufacturing 83 Figure 56: In the 2005 BEEPS Survey, firms were most concerned about tax rates, regulatory uncertainty and the cost of financing 85 viii

Figure 57: In the 2004 Enterprise Survey, firms were most concerned about financing, competition with informal firms and regulatory uncertainty 86 Figure 58: In the 2002 BEEPS Survey, firms were most concerned about regulatory uncertainty, macroeconomic instability and financing 87 Figure 59: In the 1999 BEEPS Survey, firms were most concerned about tax rates, access to finance, macroeconomic instability and regulatory uncertainty 88 Figure 60: Firms are concerned about the predictability and consistency of how laws and regulation are interpreted 94 Figure 61: Administered regulatory regimes in Bulgaria

97

Figure 62: Bulgaria compares unfavorably with the other new EU entrants with respect to the Rule of Law 113 Figure 63: Few firm managers in Bulgaria believe that the court system in fair, impartial and uncorrupted 113 Figure 64: In 2005, Bulgaria ranked towards the middle of the new EU entrants with respect to views about whether the court system was honest and uncorrupted 114 Figure 65: Large firms, exporters, and foreign-owned firms face more tax inspections than other firms do 118 Figure 66: Whereas workers education is the most serious concern of innovative firms, it does not even rank among the top concerns of less innovative firms 125 Figure 67: Bulgarian firms were less likely to provide training than firms in most other new EU entrants 125 Figure 68: Large firms, more innovative firms and firms that were concerned about skills were more likely to provide training than other firms were 126 Figure 69: Managers of faster growing firms and firms that hire unskilled and part-time workers were more concerned about labor regulation than other managers were 128 Figure 70: Employment at firms with unskilled workers has been growing faster than employment at other firms in Bulgaria 129 Figure 71: On average, manufacturing firms in Bulgaria report having few part-time workers 130 Figure 72: Part-time employment is less common in Bulgaria than in other EU countries EU 131 Figure 73: Relative share of the self-employed to the total number of the employed

132

Figure 74: After a half-decade of rapid growth, credit to the private sector was higher than in many of the other recent entrants to the EU 137 Figure 75: At the end of 2006, credit to the private sector in Bulgaria was comparable to credit in other countries with similar levels of per capita GDP 138 Figure 76: Many firms without loans do not report that access to credit was a problem—the most likely reason is that many of these firms do not feel that they need credit 140 Figure 77: Access to credit—including long-term credit (over 1 year)—has increased significantly since 1998 142 Figure 78: In 2007, firms in Bulgaria financed as much investment with bank financing and were as likely to have loans as firms in most of the other countries in the region in 2005 142 Figure 79: Large firms have better access to finance than small firms

145

Figure 80: Bulgarian firms were more likely to invest in 2006 than in 2004—although investment remained lower than in some other countries in the region 146 Figure 81: Although fewer firms used bank credit for investment in Bulgaria in 2004 than in most other EU accession countries, the rapid expansion means that this is no longer the case 147 ix

List of Tables Table 1: Macroeconomic growth in Bulgaria, 2000-2007

1

Table 2: Unemployment, labor force participation and employment rates in Bulgaria and the EU27 (%) 4 Table 3: External Sector Indicators for Bulgaria (%)

5

Table 4: FDI inflows into the new EU entrants (% of GDP)

5

Table 5: Wages and salaries have increased significantly in nominal terms since 2003

7

Table 6: Government finance in Bulgaria, 2003-2007

8

Table 7: Undeclared work in selected countries

9

Table 8: Employees according to the main sources of information (average per year)

9

Table 9: Employees in the private sector according to the Household Labor Force Survey and the Survey on Enterprises 10 Table 10: Labor productivity and labor costs (2006)

14

Table 11: Bulgaria royalty and license fee receipts are among the lowest in Europe

25

Table 12: Bulgarian firms that do conduct innovation are narrowing the technological gap

30

Table 13: Small Bulgarian firms are less innovative than medium-sized and large firms

30

Table 14: Joint ventures play a limited role in technology transfer to Bulgarian manufacturing firms 33 Table 15: Most government funding for innovation is in the form of institutional transfers

36

Table 16: Bulgarian software piracy rates remain among the world’s highest

39

Table 17: In Bulgaria, certification rates are much lower for small firms

56

Table 18: Number of EA BAS-accredited bodies each year

60

Table 19: The accreditation process is slow in Bulgaria

61

Table 20: In Bulgaria, the national accreditation body has limited private sector representation 62 Table 21: The Bulgarian accreditation lags behind in terms of international integration

64

Table 22: R&D investments at Bulgaria’s national metrology institute are aligned with regional norms 67 Table 23: Bulgaria invests a relatively important amount of resources in metrology

68

Table 24: The Bulgarian national metrology institute has a large number of staff but they are underutilized 68 Table 25: Bulgaria is a member most international metrological organizations and MRAs

69

Table 26: Bulgaria has unique separation of scientific and legal metrology responsibilities

70

Table 27: Bulgaria’s organization of standards development is similar to that of other EU countries

72 Table 28: Bulgaria’s governance structure for standardization is now in line with other countries’

72 Table 29: Bulgaria is a member of most international standards bodies

74

Table 30: Ranking of constraints in the Global Competitiveness Report, 2003-2008 (Bulgaria) 89 Table 31: The number of procedures, number of days and cost to start a business

95

Table 32: Registration and Licensing in the food processing and trade sector in Bulgaria

101

Table 33: Inspection of Hotels, Guesthouses, hostels, etc., regarding standards, by country

104

Table 34: Percent of firms, who submitted application for certification over the last two years 104 Table 35: Time and cost of closing a business, selected countries

106

Table 36: Rents in Sofia are as high as in other capitals in the region

108

Table 37: Comparison of number of procedures and number of days to deal with licenses in the construction sector in selected economies 110 Table 38: Comparison of taxation indicators in selected economies

117

Table 39: Employment rates by age group (in percent)

121

Table 40: Unemployment Rates by Age Groups in Bulgaria

121

Table 41: The Distribution of the Emigrants According to their Attitudes and by Age Groups in 2006 122 Table 42: Employment rates in Bulgaria by sex for the age group 15 - 64 (in percent)

122

Table 43: Changes in employment by sector

123

Table 44: Employment and unemployment by level of education and labor status

124

Table 45: Rigidity of Employment Indexes in 2007

127

Table 46: Part-time employees in Bulgaria

130

Table 47: Comparison of borrowing rates in the new EU member states (%)

139

Table 48: Most firms that did not apply for a loan in 2006 reported that they did not need a loan

143 Table 49: Characteristics of most recent loans

144

Table 50: Bulgaria stands fairly well in terms of “getting credit” indexes vis-à-vis comparator countries 148

List of Boxes Box 1: Learning through global buyers in Brazil’s footwear industry

32

Box 2: Government support for VC funds in Taiwan and Korea

34

Box 3: The role of industrial research institutes

41

Box 4: The role of universities in supporting innovation and technology absorption

42

Box 5: The GIS Transfer Center—an example of good practice in technology transfer

43

Box 6: The Business Innovation Center IZOT—a self-sustainable technology park

44

Box 7: The MEP and CIMO— two approaches to enhancing technology absorption in traditional manufacturing sectors 45 Box 8: The Components of the national quality infrastructure

52

Box 9: Conformity assessment and access to the EU market

54

Box 10: Administration of registration regime by the Bulgarian Municipality (2007)

98

Box 11: Food-Processing Registration in Bulgaria (2007)

98

Box 12: Training Levies

134 xi

Acknowledgements The Bulgaria Investment Climate Assessment was prepared as a joint technical assistance project of the World Bank and the Ministry of Economy and Energy. The World Bank team was led by Marialisa Motta and Roberta Gatti during the preparation stage and by George Clarke during the analysis and writing stages. The World Bank team included Mehmet Can Attacik, Evgeni Evgeniev, Maddalena Honorati, Ina Hoxha, Smita Kuriakosa, Emanuel Salinas MunĂśz and Jean-Louis Charles Racine. The Ministry of Economy and Energy team was led by Eli Anavi (Director, Enterprise Policy Directorate) and included Ivaylo Grancharov and Nikolai Istatkov. Fatiha Amar, Vessela Stamboliyska, and Cara Zappala provided outstanding document and production support. Pobeda Loukanova prepared a background note on labor markets in Bulgaria. This report is also a result of the devoted work of the translator, Simeon Enchev, who made its Bulgarian version possible.

The Enterprise Survey was designed by the Enterprise Analysis Unit of the World Bank team composed of Jorge Luis Rodriguez Meza and Vesselin Kuntchev. Evgeni Evgeniev provided invaluable help in coordinating closely with the Government counterparts and representatives of the public and private sectors and in preparing and editing the final report.

The report was prepared under the general guidance of Anand Seth, Country Director for Bulgaria before January 2008 and Orsalia Kalantzopoulos, Country Director for Bulgaria after January 2008; and Fernando Montes-Negret, Director of the Finance and Private Sector Development Department (ECSPF) of the European and Central Asia Region. Lalit Raina (Sector Manager, ECSPF) and Florian Fichtl (Country Manager for Bulgaria) provided detailed comments and strategic guidance to the team.

The team would like to thank Deputy Minister Anna Yaneva and her team at the Ministry of Economy and Energy, the members of the Consultative Council for the Promotion of Small-andMedium-sized Enterprises and the Council of Ministers’ Strategic Planning and Governance Directorate for excellent collaboration and for providing comments as the report was being prepared.

Thanks are also due to the National Statistical Institute in Sofia for preparing a firm-level dataset, executed in a very short time.

Alvaro Gonzales (Senior Economist, AFTFP), William Maloney (Lead Economist, LCRCE) and Stefka Slavova (Senior Economist, LCSPF) acted as the formal peer reviewers of the report.

Helpful comments and advice were also provided by Irina Astrakhan, Christian Bodewig, Sylvie Bossoutrot, Gerardo Corrochano, Paulo Correa, Daniel Dulitzky, Aurora Ferrari, Itzhak Goldberg, Mary Hallward-Driemeier, Stella Ilieva, Sereen Juma, Thomas Laursen, John Pollner, Donato De Rosa, Sophie Sirtaine, Ivelina Taushanova and Myla Williams.

xiii

Chapter 1: Introduction Sustained improvements in living standards depend on broad-based economic growth. This will only take place when firms improve worker productivity by investing in human and physical capital and increasing their technological capacity. But firms will only invest when the investment climate is favorable.

The investment climate affects the decisions of firms, entrepreneurs and investors on hiring and firing workers, investing in physical and human capital and developing new technologies (Stern, 2002a; Stern, 2002b; Stern, 2002c). In its broadest definition, the investment climate includes fixed factors such as a country’s climate, endowment of natural resources, and location. For operational purposes, however, the Investment Climate Assessment (ICA) focuses on things that are directly affected by government policies. These include macroeconomic stability, regulation, and incentives embodied in institutional arrangements, such as the security of property rights, the rule of law and governance. Policies in these areas affect the expected return to investment and innovation and the associated uncertainty and risk. Defined in this way, the investment climate affects the returns to and risks associated with different economic activities.

The goal of this report is to evaluate the investment climate in Bulgaria in all its operational dimensions and to recommend policies to strengthen the private sector. The ICA is largely based on results from a large firm survey that collected information on firm performance, the cost of doing business, the regulatory environment, the labor market, the financial sector, the trade regime, investment and innovation. Additional sources of information are used to supplement the survey data, including data from the World Bank’s Doing Business Report that provides detailed, comparable data on regulation across the world, data from the Sofia-based National Statistical Institute (NSI), and reports from the Government of Bulgaria, the World Bank, the International Monetary Fund, the European Union, academics, and other sources. In-depth interviews have been conducted with policy-makers, think tanks, academics and experts which enriched the understanding of the policy environment.

I. Macroeconomic Background After a serious banking and currency crisis in 1996, the Government of Bulgaria instituted a currency board arrangement that pegged the Lev to Deutsche Mark in 1997. This successfully stabilized the economy, bringing inflation down dramatically from over 1,000 percent in 1997 to only 3 percent by 1999.1 Inflation remained moderate until 2007 and early 2008 when it increased.2 Growth The banking and currency crisis that hit Bulgaria in 1996-97 resulted in a large drop in GDP—with GDP decline of -9 percent in 1996 and -6 percent in 1997. This large decline followed a large drop in GDP in the early years of the transition (average of about -6 percent per year between 1989 and 1993) and two years of modest growth (average of 2.3 percent per year between 1994 and 1995). After the crisis, GDP growth recovered.

Growth has exceeded five percent on average since 2000 and accelerated to over six percent on average after 2004 (see Table 1).

Table 1: Macroeconomic growth in Bulgaria, 2000-2007 2000 2001 2002 2003 GDP growth 5.4 4.1 4.9 5.0 (annual %) GDP per capita 7.3 6.1 5.4 5.6 growth (annual %)

2004

2005

2006

2007

6.6

6.2

6.3

6.2

7.2

6.8

6.7

6.2

Source: National Statistical Office; World Bank (2008c); 2007 data is from Eurostat ( 2007a; 2007b).

BULGARIA: Investment Climate Assessment

Although the recovery in growth has been quite impressive, it is important to keep two points in mind. First, although growth has been quite fast, growth has not been as fast as in other countries in the region—including in some of the other countries that have recently joined the European Union (EU)—and that Bulgaria’s initial income was lower than in many of these countries and, as a result, it had greater scope for convergence (see Figure 1).

Figure 1: Although Bulgaria’s growth has been strong, its initial income was lower than other countries, meaning that there was scope for convergence

Growth 2000-2005 (average per year)

20.0

15.0

10.0

5.0 Bulgaria 0.0

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

Per Capita GDP (2000 USD)

Source: World Bank (2008c).

Note: Open triangles represent the other EU accession countries, the large square represents Bulgaria and the small diamonds represent other low and middle income countries in Europe and Central Asia (ECA).

Second, investment—including foreign direct investment (FDI)—has been very high in recent years. Although growth has been impressive, it does not appear to fully reflect the very high levels of investment. This issue is discussed in detail in the next section.

Investment Since the financial crisis, investment has surged in Bulgaria. In 2000, gross fixed capital formation (GFCF) was equal to about 16 percent of GDP. By 2006, it had increased to about 26 percent of GDP (see Figure 2) and it increased further to 30 percent of GDP by 2007.3 Gross capital formation (GCF) increased even more significantly, from about 18 percent of GDP in 2000 to about 37 percent of GDP in 2007.4 This significant increase in investment reflects a long period of underinvestment, both public and private. Investment is also high in most of the other recent accession countries—GFCF is equal to at least 20 percent in all ten accession countries in Central and Eastern Europe (CEE) and is slightly higher in Latvia, Estonia, and Slovenia than it is in Bulgaria.

In 2007, enterprises and other entities in the retail trade and other service sector accounted for about one-third of expenditures on the acquisition of fixed assets—up from about 27 to 29 percent of expenditures at the beginning of the decade (see Figure 3). Manufacturing was less important accounting for about 20 percent of expenditures. In comparison, manufacturing firms accounted for between about 24 and 27 percent of expenditures between 2000 and 2002. However, because fixed investment has increased so rapidly in monetary terms, total real expenditures have increased in manufacturing even though its share of investment has fallen. Expenditures by firms in the real estate, renting and business activities sector have increased as a percent of total expenditures from about 4 to 5 percent in 2000-2001 to about 13 to 15 percent in 2006-2007.

Chapter 1: INTRODUCTION

Figure 2: Gross fixed domestic investment has increased significantly in Bulgaria in recent years—although it remains in-line with investment in other recent EU accession countries Gross fixed capital formation in Bulgaria, 1998-2006

Gross fixed capital formation in 2006, accession countries

2006

Latvia

2005

Estonia

2004

Slovenia

2003

Bulgaria Slovak Rep.

2002

Czech Rep.

2001

Romania

2000

Lithuania

1999

Hungary

1998

Poland 0

5

10

15

20

25

30

Gross Fixed Capital Formation (% of GDP)

0

10

20

30

40

GFCF (% of GDP)

Source: World Bank (2008c).

Figure 3: In 2007, most fixed investment was in the service sector—fixed investment in manufacturing accounted for only about 20 percent of investment Agriculture, Mining and other primary production 3%

Retail trade and other services 32% Source: Bulgarian National Bank (2008a).

Other 11%

Manufacturing 20%

Real Estate 13% Infrastructure 21%

Because wages in Bulgaria are lower than in the other countries in the EU and even the other new entrants to the EU (see Chapter 2), Bulgaria has a comparative advantage in low-skilled and lowwage sectors. The sector-level data appear consistent with this. In recent years, more investment has gone into sectors where wages are lower (see Figure 4).

Although investment has increased dramatically since 2002, GDP growth has increased far more modestly. As noted previously, although GDP growth has been relatively strong since the country recovered from the 1996-1997 crisis it remains below the best performing countries in the CEE region and has only increased modestly since 2002. There are several possible reasons for this disconnect. International Monetary Fund (2007b) argues that the disconnect might be partially due to current estimates of GDP growth underestimating Bulgaria’s actual growth or that there might be a delayed response to the increased investment. But it also argues that growth would increase if labor were reallocated to those sectors with the greatest growth potential. Studies have found that this has been only happening slowly. In particular, the recent Accelerating Bulgaria’s Convergence: The Challenge of Raising Productivity (henceforth, called the ABC Report) noted that most productivity growth has been due to intra-sector productivity improvements and that reallocation of resources between sectors had contributed very little to productivity improvements (World Bank, 2007a).

Improving the investment climate—and in particular making it easier for firms to respond to the improved macroeconomic climate—will also be important in translating this increased investment into improving growth and employment.

BULGARIA: Investment Climate Assessment

-0.1

2006

2005

2004

2002

2003

0

2001

Correlation between wages and share of investment across sectors

Figure 4: There is a negative correlation between wage levels and the share of investment across sectors in Bulgaria

-0.11 -0.18

-0.2 -0.23

-0.25 -0.26

-0.26

-0.3

-0.4 Source: Authors calculations based upon data from the National Statistical Institute.

Employment and Unemployment At the beginning of the decade, unemployment was very high in Bulgaria. In 2000, the unemployment rate was over 18 percent (see Table 2), considerably higher than the average for the EU (about 9 percent). Despite rapid growth at the beginning of the decade (see Table 1), unemployment did not start declining until 2003, when it fell to 13 percent. By 2007, the unemployment rate had fallen to only about 7 percent—slightly lower than the average for the EU and lower than in many of the large EU economies.5 Table 2: Unemployment, labor force participation and employment rates in Bulgaria and the EU-27 (%) EU-27/ Activity Rate (1564 years)

BG/ Activity Rate (15-64 years)

EU-27/ Employment Rate (15-64 years)

BG/ Employment Rate (15-64 years)

EU-27/ Unemployment Rate (15-64 years)

BG/ Unemployment Rate (15+years)

2000

68.5

61.6

62.1

51.5

9.2

18.2

2001

68.5

63.4

62.5

50.7

8.6

18.8

2002

68.6

62.5

62.4

51.1

8.9

18.1

2003

68.9

61.7

62.6

53.1

9.1

13.7

2004

69.2

62.8

62.7

55.1

9.2

12

2005

69.7

62.1

63.4

55.8

8.9

10.1

2006 2007

70.1 ---

64.5 66.3

64.3 65.4

58.6 61.7

8.2 7.1

9.0 6.9

Source: NSI, Eurostat.

The activity rate (i.e., people who are either employed or unemployed and looking for a job rather than out of the labor force entirely) has increased more modestly. In 2000, the share of inactive people between the ages of 15 and 65 was about 38.4 percent. By 2007, this had fallen to about one-third of the total number of people in that age group (33.7 percent). The growth of registered labor compares favorably with other EU countries—2.8 percent in Bulgaria compared to 1.1 percent in the EU 27. Growth was higher in only Estonia, Ireland and Spain (3.6, 4.4 and 3.3 percentage points). Comparing the rates of the employed, unemployed and economically inactive between 2000 and 2007, however, suggests that the growth in employment has been mainly due to inflows of the unemployed into employment, rather than inflows of inactive people into the labor force.6

Chapter 1: INTRODUCTION

Current Account Balance Since the middle of the decade, Bulgaria’s current account deficit has become very large (see Table 3). It was between 2 and 6 percent of GDP between 1999 and 2004, but increased to close to 7 percent of GDP in 2004, 12 percent of GDP in 2005 and, according to preliminary data, close to 22 percent of GDP in 2007. The increase in the current account deficit between 2004 and 2006 is mostly due to a large increase in imports of investment goods, fuel and raw materials.7 Imports of consumer goods increased only modestly.

Such large current account deficits are not likely to be sustainable in the long-run. The International Monetary Fund estimates that a sustainable level for the current account deficit is somewhere between about 5 and 10 percent of GDP and is likely to be around 8 percent of GDP for Bulgaria (International Monetary Fund, 2007a; 2007b). They note that the current levels of 15 to 20 percent of GDP are not likely to be sustainable in the medium term and that adjustment will be necessary.

Table 3: External Sector Indicators for Bulgaria (%) 1999 2000 2001 2002

2003

2004

2005

2006

2007

Current Account Balance

-4.8

-5.6

-5.6

-2.4

-5.5

-6.6

-12.4

-17.7

-21.5

Trade Balance

-8.3

-9.4

-11.7

-11.3

-13.7

-14.9

-20.2

-22.0

-25.5

30.7 39.0

38.4 47.8

37.6 49.3

36.6 47.9

37.7 51.4

40.2 55.1

43.3 63.4

47.6 69.6

46.6 72.1

Exports Imports

Source: Bulgarian National Bank (2008a).

Although the large current account deficit is of some concern, there are several mitigating factors that need to be taken into account. First, the widening of the current account deficit has not been accompanied by a loss of external competiveness. Although the real effective exchange rate (REER) has appreciated in recent years, the pace of appreciation appears to be in line with experiences in other economies in the region and that the current real effective exchange rate is in line with the International Monetary Fund’s (2007a; 2007b) estimates of its equilibrium level. Similarly, at the macroeconomic level, wage costs do not appear to show strong evidence that the currency is overvalued. Moreover, export growth has remained strong, with export reaching close to 50 percent of GDP in 2007 (See Table 3).

Second, the current account deficit has been more than covered by FDI. It was about 21 percent of GDP in 2007 and has been greater than the current account deficit in most years since 2000.

Although, in part, this reflects increased investor confidence in expectation of Bulgaria joining the EU, it is important to note that since 2003, FDI inflows have been higher than in most of the other new EU entrants (see Table 4). Because FDI is thought to be far more stable than other types of capital flows and reversals are thought to be far less likely than reversals of flows of short-term portfolio investment, there is less concern than FDI flows will quickly change direction resulting in a financial crisis.8 Table 4: FDI inflows into the new EU entrants (% of GDP) Bulgaria Czech Rep. Estonia Latvia Lithuania Hungary Poland Romania Slovenia Slovakia EU 15

2000 8.1 8.9 7.0 5.3 3.3 3.4 5.5 2.8 --10.5 2.2

2001 5.9 9.1 8.7 1.6 3.7 7.4 3.0 2.9 1.4 7.0 1.6

2002 5.9 11.3 4.0 2.7 5.1 4.5 2.1 2.5 3.9 15.6 1.3

Source: Bulgaria National Bank, Eurostat (2008).

2003 10.5 2.3 9.5 2.7 1.0 2.5 2.2 3.7 3.7 6.5 1.3

2004 13.8 4.5 8.1 4.6 3.4 4.4 4.9 8.5 2.1 7.2 0.6

2005 14.2 9.3 20.1 4.4 4.0 7.0 3.4 6.5 2.3 5.1 1.3

2006 23.6 4.2 10.1 8.3 6.1 17.5 5.6 9.3 1.7 7.5 1.4

2007 21.1 --11.7 8.0 5.0 26.6 4.2 6.0 3.2 3.9 ---

BULGARIA: Investment Climate Assessment

Finally, although the current account deficit is high, it is important to note that similar deficits have been observed on other transition economies with absorption booms (see Figure 5). In 2006, several countries including Lithuania, Estonia, and Latvia had current account deficits that were greater than 10 percent of GDP and Latvia’s current account deficit exceeded 20 percent of GDP.

0

-10

Latvia

Bulgaria

Estonia

Lithuania

Romania

Hungary

Czech

Republic

-30

Slovenia

-20 Poland

Current Account Balance (% of GDP)

Figure 5: Although Bulgaria’s current account deficit is high, several of the recent EU accession countries from Central and Eastern Europe also have high current account deficits in 2006

Source: World Bank (2008c).

Between 1999 and 2006, manufacturing accounted for a greater share of FDI than any other sector (about 24 percent). The next most important sectors were real estate operations, renting and business services (16.3 percent) and financial intermediation (16.1 percent) (Bulgarian National Bank, 2007).

According to data compiled by the International Monetary Fund (2007a), FDI inflows into manufacturing were lower as a share of total FDI in Bulgaria than in most of the recent EU accession countries for which comparable data were available. For example, FDI in manufacturing accounted for about 46 percent of the stock of FDI in Slovenia, about 44 percent in Hungary, and about 40 percent in the Czech Republic and Slovakia.

In recent years, FDI has shifted away from manufacturing towards other sectors in Bulgaria. In 2007, real estate, renting and business services accounted for over one-third of investment, with financial intermediation accounting for close to an additional third and construction accounting for about 12 percent (see Figure 6). In addition to the acquisition of real estate, FDI in real estate, renting, and business services includes the construction and acquisition of commercial and industrial buildings, investment in real estate operations, and equipment rental services (Bulgarian National Bank, 2007).

Although the absorption of large parts of FDI into non-tradable sectors is a concern, the International Monetary Fund (2007a) notes that globalization has made it more difficult to sharply delineate tradable and non-tradable sectors and that total investment—as opposed to foreign direct investment—in the tradable sector in Bulgaria has remained broadly unchanged.

However, this shift emphasizes the need to improve the investment climate to promote investment—both domestic and foreign—in export-oriented manufacturing.

In the context of the currency and banking crisis, inflation accelerated significantly in Bulgaria reaching over 1,000 percent in 1997. It fell significantly in the years after this reaching 19 percent in 1998 and 3 percent in 1999. Since 2000, inflation has mostly remained between about 5 and 10 percent (see Figure 7). After falling to close to 4 percent in April 2007, year-on-year inflation had increased to close to 6 percent by July 2007 and had accelerated further—to over 11 percent—by the time the Enterprise Survey was completed in December 2007. Several factors might be playing a role in the increase in inflation including the very rapid expansion in credit (see Chapter 7) and the relatively fast economic growth.

Chapter 1: INTRODUCTION

Figure 6: In 2007, most FDI was in real estate, renting and business activities; financial intermediation; and construction Manufacturing 2%

Other 7%

Wholesale and retail trade 10%

Real estate 38%

Construction 12%

Financial intermediation 31%

Source: Bulgarian National Bank (2008a).

Inflation

10

January .08

July .07

January .07

July .06

January .06

July .05

January .05

July .04

January .04

July .03

January .03

July .02

January .02

July .01

January .01

July .00

0 January .00

Consumer Price Inflation (year-on-year change)

Figure 7: Consumer price inflation has been modest—but not low since the beginning of the decade

Source: National Institute of Statistics.

Although inflation is far below the hyper-inflationary levels observed during the crisis, inflation remains above the levels observed in other EU countries. Inflation was only about 2 percent in the Euro area during 2007—far lower than in Bulgaria.

In addition to the increase in consumer prices, wages and asset prices have also been increasing rapidly in recent years. Although wages remain low compared to other countries in the European Union, including the other recent new entrants (see Chapter 2), wages have increased significantly since 2003. After several years of relatively modest growth after the crisis, nominal wage growth averaged over 10 percent per year between 2003 and 2007 and continued to accelerate in the first quarter of 2008 (see Table 5).

Table 5: Wages and salaries have increased significantly in nominal terms since 2003 2003 2004 2005 2006 2007 Q1 2008 Average monthly wages and 273 292 324 360 431 484 salaries (BGN) Source: Bulgarian National Bank.

BULGARIA: Investment Climate Assessment

As well as the rapid increase in wages, there has also been a significant increase in asset prices over this period. Apartment prices increased close to three-fold between 2003 and 2007.9 Similarly, the stock market index has increased over 16 times since the end of 2001. The International Monetary Fund (2007b) argues that EU membership has meant that investors believe that risk has fallen and expect asset prices to converge to higher levels observed in other EU member countries.

Government Finances Prudent fiscal policy has played a positive role in reducing country risk and improving the investment climate. In recent years, Bulgaria has been running modest and increasing budget surpluses. Total expenditures, including interest expenses, have slowly fallen relative to GDP. Whereas, total expenditures were about 40.6 percent of GDP in 2003, they had fallen to about 38.8 percent by 2007 (see Table 6). At the same time, government revenues have increased from 40.6 percent in 2003 to 42.6 percent in 2007. The increase in revenues is due to increased tax revenues, which have increased from 32.1 percent to 34.2 percent over this period.

Table 6: Government finance in Bulgaria, 2003-2007 (% of GDP)

2003

2004

2005

2006

2007

Revenues and Grants

40.6

40.8

42.0

40.6

42.6

Total Expenses

40.6

39.1

38.9

37.0

38.8

2.1

3.5

4.7

4.8

4.9

48.1

40.1

31.3

24.8

19.8

Primary Balance Government and Guaranteed Debt

Government

Source: Bulgarian National Bank.

Note: Primary balance excludes interest expenses.

Increasing revenues and falling expenditures have resulted in a large increase in government surplus. The primary surplus has increased from 2.1 percent of GDP in 2003 to 4.9 percent by 2007. The cash surplus has also increased—from 0.0 percent of GDP in 2003 to 3.8 percent of GDP in 2007. This has resulted in a large drop in government indebtedness (see Table 6). Given that currency board arrangements can be vulnerable to external imbalances, the large fiscal surpluses are important to ensure its medium-term sustainability.10

II. The Informal Sector The informal sector is both difficult to define and difficult to measure. Standard definitions usually revolve around the production of market-based goods that are legal but that are deliberately concealed from public authorities to avoid taxes, social security contributions, regulatory requirements for employing workers, or complying with administrative procedures and other regulations (Schneider and Enste, 2000; Schneider and Klinglmair, 2004).

Because production is deliberately concealed it is almost by definition difficult to measure informality accurately. As a result, it is difficult to reach a consensus estimate of the importance of informality and hence difficult to either compare levels across time or across countries. Keeping this in mind, the evidence that there is suggests that informality is relatively high in Bulgaria and that it might have increased prior to 2007.

The size of the informal sector One recent attempt to measure the size of the informal sector was through a questionnaire survey carried out by the Bulgarian Industrial Association (BIA). Based upon this, the BIA estimated that the informal sector accounted for about 35 percent of the economy and had expanded between 2004 and 2007.11 They estimated that if employment in the informal economy was added to GDP then growth would increase from the officially reported rate of 6.5 percent for 2006 to 7.8 percent and that income would be 13 percent higher.

The survey results indicated that 18 percent of private sector employees pay social security contributions on their full income and that about two-thirds (63 percent) of all employees pay taxes and contributions on their real income.

Chapter 1: INTRODUCTION

A second survey, the nationally representative empirical sociological survey “Factors for applying flexible retirement forms and promotion of elderly employment” estimated that 87 percent of interviewees think that employers hire workers without contracts, and 90 percent believe that employers pay social security contributions on the minimum insured income, not on the entire salary.12 The high number of respondents sharing this opinion is evidence of the broad scope of concern about informality.

A related concept to informality is the concept of undeclared work, which is defined as “productive activities that are lawful as regards to their nature, but are not declared to the public authorities, taking into account the differences in the regulatory system between Member States.”

(Renooy and others, 2004). Based upon a survey in 2002, Renooy and others (2004) concluded that undeclared work accounted for between 22 and 30 percent of GDP in Bulgaria—higher than in most EU members, including recent entrants (see Table 7). Although alternative surveys are carried out periodically by research centers/institutes, trade unions and the employers’ organizations, no similar results are available from new surveys since 2002.

Table 7: Undeclared work in selected countries New EU entrants Selected EU 15 Members Country % of GDP Country % of GDP Bulgaria 22-30% Austria 1.5% Czech Republic 9-10% Belgium 3% Estonia 8-9% Denmark 5.5% Hungary 18% Finland 4.2% Latvia 18% France 6.5% Lithuania 15-19% Germany 6% Poland 14% Greece 20+% Romania 21% Italy 17% Slovak Republic 13-15% Netherlands 2% Slovenia 17% Sweden 3% UK 2% Source: Renooy and others (2004) аnd (World Bank, 2007a).

Another way to estimate informality is to compare estimates of the number of employed people estimate from surveys of enterprises (labor accounts method) with estimates from Labor Force Surveys (LFS) of the households. This might give some idea about the level of undeclared work if enterprises are less willing to disclose the true size of their workforce than individuals are (see Table 8). Although these numbers are not comparable with the numbers estimated from firm surveys, they provide an interesting source of information.

Table 8: Employees according to the main sources of information (average per year) Number of the Employees (in thousands) Difference according to: Percent Year (in Survey of the Households Labor Force difference thousands) Enterprises Survey (HLFS) 2003 2004 2005 2006

Source: NSI.

2079.9 2152.3 2177.2 2267.7

2399.6 2478.7 2555.7 2701.5

319.7 326.4 378.5 433.8

13% 13% 15% 16%

The difference of the numbers of the employed according to these two surveys could be considered as a sign about the existence of undeclared work, but it does not provide a precise measure about its scope and the results are not comparable with the previous analyses mentioned. With these provisos, estimates give little evidence that informality had fallen significantly in recent years A better way of measuring employment in the grey sector might be to compare information only about people employed in the private sector.13 The two measures might be more comparable between the two surveys and therefore the differences between them might be a better illustration of the scope of the grey employment (see Table 9). The increasing values of the differences—at least since 2004—suggests that employment in the informal sector might have even increased in recent years.

10

BULGARIA: Investment Climate Assessment

Table 9: Employees in the private sector according to the Household Labor Force Survey and the Survey on Enterprises Number of the Employees in private sector (in thousands)

Year

Households Labor Force Survey (HLFS) 1198.1 1423.4 1497.1 1599.7 1697.2

Survey of the Enterprises

2003 2004 2005 2006 2007

1418.0 1569.8 1690.9 1841.7 2010.1

Source: NSI.

Difference (in thousands) (private only)

Percent difference (private only)

219.9 146.4 193.8 242.0 312.9

18% 10% 13% 15% 18%

Although it is difficult to accurately measure the size of the informal sector, the evidence that exists suggests that it is fairly large in Bulgaria—perhaps as large as 30 to 35 percent of GDP according to some estimates and that it might have increased in recent years. The recent reforms to the social security might have reduced informality in 2007/2008, but data are not yet available to see if this is the case.

Evidence from the Enterprise Survey The 2007 Enterprise Survey, which is described below, also provides some information on informality in Bulgaria. Firms were asked whether they compete with unregistered and informal firms. About 60 percent of firms said that they did. In comparison, only about 32 percent of firms in Croatia said the same.14 This suggests that informality is relatively high in Bulgaria.

Competition with informal firms is not just a problem for small firms or firms in sectors such as retail trade. Firms of all sizes and in most sectors report that they compete with informal firms.

Although it seems plausible that larger enterprises might face less competition from informal enterprise than smaller enterprises do, this does not seem to be the case (see Figure 8).15

100% 75% 50%

Non

Exporters

Exporters

Large

Medium

Small

Micro

Manufacturing

Source: World Bank Enterprise Survey.

Services

Retail

0%

IT

25%

All

% of firms competing with informal firms

Figure 8: Firms in the IT sector are less likely to compete with informal firms than other firms are

There were, however, some differences. Firms in the Information Technology (IT) sector were far less likely to say that they competed with informal firms than firms in other sectors (retail trade, services, and manufacturing). Only about one-quarter of IT firms said that they competed with informal firms compared to between about 55 and 65 percent of firms in other sectors. Exporters also were less likely to say that they competed with informal firms. One reason for this might be that most exporters do not believe that they are competing with informal firms in the foreign markets that they are exporting to. But even exporters that sell a large share of their output in Bulgaria (i.e., exporters that export less than half their output) are less likely to say that they compete with informal firms than purely domestic firms (53 percent compared to 61 percent). This suggests that exporters might compete in higher value-added areas even within Bulgaria.

Chapter 1: INTRODUCTION

11

III. The Enterprise Survey The main source of information for the Bulgaria Investment Climate Assessment is an enterprise level survey that was conducted between July and December 2007. The Bulgaria 2007 Enterprise Survey has been designed as part of the World Bank’s Enterprise Survey rollout. The World Bank Enterprise Surveys (ES) collect data from key manufacturing and service sectors in every region of the world. The Surveys use standardized survey instruments and a uniform sampling methodology to minimize measurement error and to yield data that are comparable across countries.

Information from the survey is supplemented with information from other sources, including the Doing Business Report (World Bank, 2007b); analytical reports by the World Bank, including the recent ABC Report (World Bank, 2007a), and reports from the International Monetary Fund, data from the National Statistical Institute, and reports from other international organizations, the Government of Bulgaria, and academic papers.

Sampling The Enterprise Surveys target the non-agricultural economy including the manufacturing and services sectors with the exception of financial services, mining, public services (e.g., health and education), and public utilities. The sampling methodology used for all of the World Bank’s Enterprise Surveys generates samples sizes appropriate to achieve two main objectives: first, to benchmark the investment climate of individual economies across the world and, second, to conduct firm performance analyses focusing mainly on determining how investment climate constraints affect productivity and job creation in selected sectors.

To achieve both objectives for Bulgaria, the sampling methodology will generate a sample representative of the whole economy that will allow correct inferences about the whole economy, not only about the manufacturing sector. The sample includes, in addition to selected manufacturing industries, services industries and other relevant sectors of the economy. The sampling methodology generates large enough sample sizes for selected industries to conduct statistically robust analyses with levels of precision at a minimum 7.5 percent precision for 90 percent confidence intervals about estimates of population proportions (percentages), and estimates of the mean of log of sales at the industry level. Both objectives are achieved by stratifying the sample and by defining minimum stratum sizes of 120.16 Stratification To reflect the overall composition of the Bulgarian economy the sample was drawn from a universe defined as follows: all manufacturing sectors (group D), construction (group F), services (groups G and H) and transport, storage, and communications (group I).

The universe of industries was stratified into several manufacturing industries, two services industries (retail and IT) and a residual. To keep results comparable with previous surveys and with other countries, two manufacturing industries were selected as strata: manufacture of food products and beverages (ISIC 15), and manufacture of wearing apparel and fur (ISIC 18). Four additional industries were chosen based on their contribution to value added, employment, and number of firms: chemicals (ISIC 24); fabricated metal products (ISIC 28); machinery and equipment (ISIC 29) and electronics (ISIC 31-32). With the addition of two services sectors, retail and IT, and one residual stratum, the final sample size is 1,015 firms.

The overall sample was also stratified by firm size and location. Firm size was defined following the standard of every Enterprise Survey: small (5 to 19 employees), medium (20 to 99 employees), and large firms (more than 99 employees). In terms of location, the four more important economic regions of Bulgaria were included: Sofia, Plovdiv, Varna, and Bourgas. Weights were constructed to allow for statistics to be generated for the entire urban economy (excluding the sectors that were not sampled at all).

Chapter 2: Firm Productivity This chapter looks at how manufacturing enterprises in Bulgaria perform compared with similar firms in the other new EU entrants. This approach using firm-level data is complementary to the macroeconomic approach in the ABC Report (World Bank, 2007a). The different measures of firm performance indicate how competitive manufacturing is in global, EU, and local markets. It also looks at the association between various firm and investment climate characteristics and firm productivity. While this chapter provides an overview of how well firms in Bulgaria perform, later chapters assess how the investment climate affects their competitiveness.

The chapter looks at three broad measures of competitiveness: (i) labor productivity; (ii) labor costs; and (iii) technical efficiency. The first is a simple measure of how much output the firm produces per worker. One advantage that it has over other measures of productivity is that both output and number of workers are relatively easy to measure and compare across countries. The second measure is labor costs. Although labor productivity is a useful measure of firm productivity, unproductive firms can remain competitive if they pay low wages. Labor costs are therefore an important complement to labor productivity. The final measure is technical efficiency. One advantage that is has over labor productivity is that it takes capital use into account. But it is also more difficult to compute, there are more methodological issues when estimating it, and, because capital is poorly measured for many firms, it is more difficult to estimate accurately.17 The results in this section use data for manufacturing firms only. One reason for doing this is that many of the concepts (e.g., technical efficiency) were developed for manufacturing firms and crosssector comparisons are therefore difficult. But, just as important, productivity data were collected only for manufacturing firms in the Enterprise Survey, meaning most comparisons could not be made for firms in other sectors in any case.

I. Labor Productivity Labor productivity, the per worker output that the firm produces less the cost of raw materials (such as iron or wood) and intermediate inputs (such as engine parts or textile inputs) used to produce the output, is a basic measure of firm productivity. Labor productivity is higher in firms that produce more with fewer raw materials and fewer workers. Differences in labor productivity can be the result of differences in technological know-how, differences in organizational structure, differences in worker skills, differences in management ability, or differences in the amount of or the quality of machinery and equipment that the firm uses. Because labor productivity does not take the use of capital (i.e., machinery and equipment) into account, it will be higher in firms that use capital in place of labor (i.e., firms that are capital intensive).The median manufacturing firm in the Enterprise Survey produced about US$6,000 of value added per worker (see Figure 9). This was relatively close to the value-added per worker for the median firm in Latvia or Romania. But, it is considerably lower than in the best performing of the new EU entrants, where the median firms are often over twice as productive.

Although these comparisons should be treated with some caution due to small sample sizes for the other recent EU entrants, this is broadly consistent with other evidence. For example, Eurostat collects data on GDP per worker for all EU members. Eurostat’s measure is different from the measure based upon firm-level data here because it averages productivity over the entire economy and therefore includes sectors other than manufacturing.

Despite this, a similar picture comes from looking at this data. Labor productivity is lower in Bulgaria than in any of the other new EU entrants (see Table 10). Given the small sample sizes in the Enterprise Surveys used to calculate productivity levels in the comparator countries and the differences in the two measures, it is not surprising that the two measures are not identical. They 13

14

BULGARIA: Investment Climate Assessment

are, however, very highly correlated (correlation is 0.83). Moreover, they present similar conclusions with respect to Bulgaria—labor productivity is lower in Bulgaria than in any of the comparator countries based upon both measures.

$25 000 $20 000 $15 000 $10 000

Source: World Bank Enterprise Surveys.

Note: The data for other countries come from World Bank Enterprise Surveys in 2005 and 2006

Table 10: Labor productivity and labor costs (2006) Hourly Labor Cost (Euros) Bulgaria

Labor productivity (% of EU Average)

1.65

34.9

Czech Republic

7.14

70.7

Estonia

5.5

64.3

Hungary

6.34

74.5

Latvia

3.41

50.9

Lithuania

4.21

57.1

Poland

6.03

61.1

Romania

2.68

39.2

Slovakia

5.33

71.8

Slovenia

11.29

84

Source: Eurostat (2008).

Slovakia

Hungary

Poland

Estonia

Czech Republic

Lithuania

Romania

$0

Latvia

$5 000

Bulgaria 2007

value - added per worker (US$)

Figure 9: Labor productivity is lower in manufacturing in Bulgaria than in other recent EU entrants

Chapter 2: Firm Productivity

15

II. Labor Costs Given that manufacturing firms in Bulgaria are less productive than firms in other EU countries, a natural question is how they manage to stay competitive in an open market such as the European Union. One important reason is that wages and labor costs are lower in Bulgaria than in other EU countries. The median firm in the 2007 Enterprise Survey reported that labor costs were equal to about $2,000 (2005 US$) per year. Although this was relatively close to wage levels in Romania and Latvia, it is lower than in most of the other recent entrants to the EU (see Figure 9).

Once again, despite the small samples in some of the Enterprise Surveys, this is consistent with other information. In particular, Eurostat collects data on labor costs per hour worked. As before, this differs from data from the Enterprise Survey in several important ways. The Eurostat measure covers the entire economy, not just manufacturing, and the Eurostat measure is labor costs for each hour worked rather than labor costs per worker. The two measures are very highly correlated at the country level (0.92) and labor costs in Bulgaria are lower than in any of the other countries for both measures (Table 10 and Figure 10).

Figure 10: Labor costs are also lower for manufacturing firms in Bulgaria

$7 500

$5 000

Estonia

Hungary

Slovakia

Czech Republic

Poland

Lithuania

Latvia

$0

Romania

$2 500

Bulgaria 2007

labor costs per worker (US$)

$10 000

Source: World Bank Enterprise Surveys.

Note: The data for other countries from 2005 and 2006.

III. Technical Efficiency The results presented in the previous subsection have some drawbacks. The main problem is that when considered in isolation, labor productivity can present incomplete evidence on firm performance. Technical efficiency (TE)—which is analogous for firm-level analysis to total factor productivity (TFP) in macroeconomic and sectoral studies—avoids some of the problems associated with labor productivity by taking both capital and labor use into account simultaneously. Differences in TE between firms (e.g., between firms in different countries or between exporters and nonexporters) are due to differences in things other than capital or labor. For example, differences in TE might be due to differences in firm organization, management efficiency, worker skills or education, or the investment climate. To the extent that differences in technology are not embedded in the machinery and equipment that the firm uses, differences in technical efficiency can also reflect technological differences.

The econometric methodology used to calculate TE is described in detail in Appendix 2.1. The appendix explains how TE is calculated, provides more detail on the results in the chapter, and discusses various limitations of the analysis.

16

BULGARIA: Investment Climate Assessment

Cross-Country Comparisons 300%

200%

100%

Hungary

Estonia

Slovakia

Poland

Czech Republic

Lithuania

Latvia

Romania

0% Bulgaria

as % of TE in Bulgaria, 2007

Figure 11: Technical efficiency is lower in Bulgaria than in the other EU accession countries

Source: World Bank Enterprise Surveys.

Note: TE is calculated based upon the coefficient estimates for the country dummies from the unrestricted LAD regressions described in the Appendix 2.1. Formula for effect of a dummy variable is from Kennedy (2003, p.

123). See Halvorsen and Palmquist (1980) for the derivation.

As a first exercise, average levels of technical efficiency are calculated for Bulgaria and the other new EU entrants. Technical efficiency is consistently lower in Bulgaria than in the any of the other countries (see Figure 11). Although it is relatively close to productivity levels observed in Romania (as well as Latvia and Lithuania), productivity remains lower than in the best performing of the new EU entrants such as Estonia and Hungary. Because technical efficiency takes into account both capital and labor use and sector and firm size, this suggests that productivity is not lower in Bulgaria than in the comparator countries simply because firms are in less productive sectors or because they use less capital than firms in the other EU entrants.

Technology So, what affects technical efficiency in Bulgaria? To look at this question, the econometric analysis in the appendix looks at factors that appear to have the largest and most robust associations with technical efficiency using the data from the 2007 Enterprise Survey. Although, as discussed above and in the technical appendix, the econometric results must be treated with some caution due to various methodological issues, the robust results from the analysis are an important complement to the other qualitative and quantitative evidence presented in later chapters. Moreover, many of the results reinforce the other evidence.

Technology and its adoption appear to be particularly strongly associated with technical efficiency in Bulgaria. Firms that license technology from abroad, firms that have ISO certification and innovative firms that have introduced new products are more productive than other firms in Bulgaria. The differences are large. Estimates from the different models (see Appendix 2.1) suggest that firms that have introduced new products in the past three years are about 5 and 29 percent more productive than firms that have not, firms with ISO certification are about 19 and 33 percent more productive than firms that have not and firms that license from foreign firms are about 40 and 63 percent more productive than those that do not (see Figure 12).

For all three variables, it is difficult to fully assess whether the firm is more productive because they adopt new technologies or that more productive firms have more resources to invest in new technologies (i.e., it is difficult to determine the direction of causation). For example, one plausible explanation why ISO certified firms are more productive than non-certified firms is that the process of quality improvement requires that firms carefully assess their processes and organizational performance and that this in turn improves their efficiency. Another possibility is that the process of ISO certification improves either the quality of their products or acts as a signal of quality, allowing them to command higher prices on international markets. However, it is also possible that causation might partly run in the opposite direction. That is, firms that are already producing quality goods and are already well organized might find it easier to become internationally certified than other firms. This interpretation is consistent with other evidence that suggests that although international

Chapter 2: Firm Productivity

17

certification provides a useful market signal that a firm is adhering to a recognized management system there is mixed evidence that it actually improves quality and organizational performance in the firm (Guasch and others, 2007). As discussed in Chapter 4, it is therefore important to emphasize that certification is a first step to further quality upgrading and not an end in itself. Government programs to promote or encourage quality improvements should recognize this.

Figure 12: Innovative firms are more productive in Bulgaria increase in TE over non-innovative firms

75%

50%

25%

0%

Firm licences foreign technology

Firm has ISO certification

Firm has introduced new product

Source: World Bank Enterprise Surveys.

Note: TE is calculated based upon the coefficient estimates for the country dummies from the OLS TE regressions described in the Appendix. The bar indicates the high and low estimates from different models. All percentages are the percentage differences in productivity between firms that do and do not do that activity. For example, the results suggest that firms that are ISO certified are about Formula for effect of a dummy variable is from Kennedy (2003, p. 123). See Halvorsen and Palmquist (1980) for the derivation.

Similarly more innovative firms might be more productive because firms that are innovative are able to update their product lines and hence find it easier to compete on things other than price (e.g., quality). But other omitted firm-level characteristics might also play a role. For example, firms that are better managed will probably find it easier to introduce new products and are also likely to be more efficient in other ways. In this respect, rather than simply subsidizing R&D, it would be more important to encourage firms to adopt the best practices of innovative firms. Firm innovation is discussed in detail in Chapter 3.

Before controlling for other factors such as innovation, quality certification and licensing foreign technologies, exporters appear to be about 22 percent more productive than similar non-exporters.

However, the econometric analysis suggest that this might be at least partly because they are more innovative. Exporters are more likely to license foreign technologies than non-exporters (12 percent of exporters compared to 8 percent of non-exporters), more likely to be ISO certified (44 percent compared to 26 percent) and more likely to have introduced new products (64 percent compared to 59 percent). The steps that firms have to take to successfully enter export markets might be more important (e.g., improving quality and products) than simply exporting.

Other aspects of the investment climate Other investment climate-related factors also appear related to firm-level productivity in Bulgaria. Figure 9 shows the impact of improving various measures of the investment climate to the levels observed in the best performing countries in the region on firm productivity. Although various econometric issues, especially related to the direction of causation, mean that it is difficult to draw strong conclusions based upon the econometric analysis (see Appendix 2.1 for discussion), the burden of regulation, the cost of crime and security, and worker skills all appear to be related to productivity.

Based upon the point estimates, reducing the burden of regulation (i.e., the time that senior managers spend dealing with regulations) to the levels observed in the best-performing countries could increase productivity by between 1 and 7 percent. Reducing security costs to the levels of the best-performing countries in the region could increase productivity by between about 10 and 18 percent.

Increasing the share of skilled workers could increase productivity by about 6 and 12 percent, increasing access to bank financing could increase productivity by between about 2 and 5 percent and increasing worker training could increase productivity by about 3 and 5 percent.

18

BULGARIA: Investment Climate Assessment

difference in TE if Bulgaria moved to best practice

Figure 13: Impact of improving investment climate variables so that they are equal to the best performing countries in the region 20% 15% 10% 5% 0%

Working Training Time senior % of skilled Security costs capital management workers financed with spends bank dealing with financing regulations Source: World Bank Enterprise Surveys.

Note: TE is calculated based upon the coefficient estimates for the country dummies from the OLS TE regressions described in Appendix 2.1. The percentages are calculate by multiplying the semi-elasticity for that variable by the difference in that variable between Bulgaria and the first or second best performing country among the new EU entrants or other groups of comparators. Formula for effect of a change in the variable is from Kennedy (2003, p. 123).

It is important to note that these estimates depend mostly upon two factors—the estimate of the semi-elasticity from the econometric model, which measures how strong the relationship is between productivity and the measure of the investment climate—and how far away Bulgaria is in that area from best practice. For example, the burden of regulation and security costs (see Chapter 6) are both high in Bulgaria and so are relatively far from best practice. The potential for improvement in these areas is therefore greater. In contrast, Bulgaria compares relatively favorably with respect to access to finance (see Chapter 8) and so improving to the level observed in the best performing countries suggests a relatively smaller increase for any given semi-elasticity.

As well as looking at the percent of working capital financed with bank financing, the analysis also looks at simple indicators of whether the firm has a loan or overdraft (rather than the size of that loan or overdraft). These variables are not as strongly related to productivity. One possible reason for this might be that access to loans has increased significantly in recent years and, as discussed in Chapter 8, many firms without loans do not appear to want them. Thus, one explanation for this might be that although firms can generally get some type of loan if they want one, there are still concerns associated with getting a loan on favorable enough terms (e.g., in terms of the size of an available loan). In this respect, although firms are not credit constrained in that they can get loans, they might remain credit constrained in terms of not being able to get enough credit. Hence the size of the loan rather than whether the firm can get a loan at all might be driving some of these results.

No variable related to infrastructure is strongly related to productivity (see Appendix 2.1). This, of course, does not mean that infrastructure does not affect productivity.18 Although, as discussed in Chapter 5, firm managers are becoming more concerned about infrastructure and the objective data also suggests some deterioration in quality, overall quality remains relatively good. Thus, it might not be surprising that infrastructure is not currently a large constraint on firm performance.

Given the strong association between productivity and innovation, the next chapter discusses innovation in Bulgaria. Improving firm performance with respect to both creating and absorbing knowledge could potentially have a significant effect on firm performance.

Chapter 3: Innovation & Technology Absorption With the increased pace of global technological change, the Fordist model of long production runs and large volumes is no longer valid. Short product life cycles and high product differentiation benefit innovators over imitators. Imitators must acquire the relevant technologies fast enough while depending on low factor costs, flexibility or reliability to become competitive. However, there is no reason to expect technology to flow effortlessly to imitators. Technology absorption is a long risky process fraught with market imperfections and systemic failures. If nothing is done to accelerate the diffusion process, technology can be obsolete by the time it flows to imitator firms.

As a technology-follower, Bulgaria’s challenge is to react to a dynamic environment where the technological frontier is constantly being pushed forward by more technologically-advanced countries. Bulgarian firms must acquire technologies faster than the technology frontier is being expanded or face a widening technological gap. At the same time as it strives to acquire existing technologies, Bulgaria cannot ignore innovation. Technological absorptive capacity, the ability to identify, adopt and adapt existing technologies, depends on a culture of innovation and tacit knowhow acquired by conducting research. Bulgaria must start building research and development (R&D) capacity in its firms, universities and institutes to lay the grounds for a competitive knowledge economy. Research systems can take decades to develop and countries that invested early in their research infrastructure, such as South Korea, were able to benefit from increased capacity to innovate at later stages of development.

The Bulgarian Government has recently given innovation and technology absorption a more prominent position in its agenda, with respect to its goals of narrowing the productivity gap with other EU countries and reaching the objectives of the Lisbon Strategy. As a result, a number of new strategies, policies, institutions and programs for innovation and technology absorption have been established in the past five years. However, new instruments to promote innovation have not always been adopted in a coherent manner through a clear strategy tailored to national priorities and a number of institutional challenges dating from the centrally planned economy remain in place today.

Moreover, the rhetoric on innovation and technology absorption has not been matched by large increases in productive investments from either the public or private sectors and many innovation support programs remain embryonic. In spite of these challenges, Bulgaria is well-positioned to leverage its EU membership and proximity to the quality-driven markets of Western Europe to embark on a path of sustainable technological upgrading.

I. Coordination of the Bulgarian National Innovation System Institutions The Ministry of Economy and Energy and the Ministry of Education and Science are the government bodies that play the dominant roles in developing Bulgaria’s national research, innovation and technology strategy and policy. Several other entities are involved but with a more narrow scope.

The Ministry of Economy and Energy (MoEE) is responsible for the formulation of innovation policy and strategy in the business sector. The National Council for Innovation is a consultative body to the MoEE and includes representatives from the business sector, academia, the scientific community and NGOs. The Bulgarian SME Promotion Agency (BSMEPA), which reports to the MoEE, prepared and now implements the measures of the National Innovation Strategy, including the administration of the National Innovation Fund established in 2004.

The Ministry of Education and Science (MES) is responsible for national research policy. The National Council for Scientific Research is the coordinating body for research policy, and is comprised of representatives from ministries and scientific organizations. The National Council for Scientific 21

22

BULGARIA: Investment Climate Assessment

Research participates in the preparation of and approves the National Strategy for Research and Development, and defines funding priorities for the National Science Fund, established by the MES in 1990.

A number of other ministries play a smaller role in innovation policy. The Ministry of Labor and Social Policy is involved in several entrepreneurship programs. The Ministry of Agriculture and Food organizes and funds the National Center for Agrarian Science. The Ministry of Health oversees seven National Medical Research Centers. The State Agency for Information Technologies and Communications pursues the state policy in the field of IT and communications.

Strategic Framework A number of strategies and laws concerning research, innovation and technology have been adopted in the past five years as Bulgaria has strived to follow EU best practice. The National Innovation Strategy (NIS) provides measures to encourage innovation, bridge the gap between research and industry, and increase the competitiveness of the Bulgarian private sector. The NIS, adopted by the Bulgarian Government in 2005,19 includes financial measures such as the National Innovation Fund, as well as non-financial measures such as employment programs for young specialists in SMEs, developing or improving technology centers, building clusters, attracting FDI in R&D and establishing university entrepreneurship centers. А Draft National Strategy for Research and Development for the Period 2005-2013 (NSRD) was recently developed. It presents measures to set research priorities, develop human potential for research and integrate Bulgaria into the European Research Area. The NSRD includes measures for more effective governance of national R&D, measures for public R&D funding, measures to promote the competitiveness of research, measures to integrate higher education in the scientific and research activity of the country, and measures to increase private investment in R&D. The NSRD has not been approved by the Council of Ministers.

Upon joining the EU, the Bulgarian Government developed several strategic documents in line with EU R&D and innovation priorities. In March 2007, the Government adopted the National Program for Reforms 2007-2009 entitled, “For Higher Growth and More Working Places”, which integrates the objectives of the Lisbon Strategy and calls for the prioritization of R&D and innovation. The National Strategic Reference Framework 2007-2013, also adopted in March 2007, provides guidelines for the use of EU Structural Funds through seven Operational Programs, several of which support the goals of the Lisbon Strategy in the area of R&D and innovation. These two strategic documents, required by the European Commission, are in line with the National Innovation Strategy.

Research, innovation and technology policy is fragmented in Bulgaria, resulting in programs with overlapping objectives, partial coherence and a poor rationalization of resources. There is no single entity responsible for research, innovation and technology policy priorities. The NRSD was developed at a different time and under a different ministry than the NIS--the Ministry of Education and Science (MES) and the Ministry of Economy and Energy (MoEE) respectively, with cross-consultations limited to minor representation of one ministry on the other’s consultative or coordinating body. In an era where scientific results are translated ever more quickly into industrial applications it is difficult to argue for a clear separation of basic and applied research, or of research and innovation policy.20 Measures designed to promote innovation must account for the highly interdependent links between all of the elements of the national innovation system, including universities, research centers, firms, consultants and industry associations. As noted in the ABC Report (World Bank, 2007a), international experience shows that more effective and coherent policies can be developed through a single coordinating body and a single integrated strategy for research, innovation and technology. Further, with the realization that research and innovation are of high interest to a number of ministries, EU countries are increasingly giving the task of developing their national strategies to supra-ministerial bodies. In Ireland, the Cabinet Sub-Committee on Science, Technology and Innovation is at the apex of the national governance structure on science and technology. In Spain, the pluriannual National Plan for R&D and Innovation is assigned to the Inter-ministerial Commission on Science and Technology, chaired by the Prime Minister.

23

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

II. Performance of the National Innovation System Bulgaria ranks 88th of 131 countries on the innovation pillar of the Global Competitiveness Report 2007-2008 (Porter and others, 2007). Within the components of the innovation pillar, the country performs particularly poorly in company spending on R&D (103rd) and University-industry research collaboration (95th), but more favorably on Availability of scientists and engineers (65th).

If the overall performance of Bulgaria’s national innovation system is measured by outputs of the productive sector, including value added in higher-technology sectors, patents and exports, it does not compare well with other EU countries. Still, some signs point in a positive direction.

Industrial Structure Highly innovative economies tend to specialize in producing skills-intensive goods and services associated with rapid technological change and high value added. There is a two-way causal relationship in that these technology-intensive sectors generally offer greater opportunity and need for innovation than labor-intensive sectors. In 2005, low technology firms contributed to 53 percent of manufacturing value added in Bulgaria, placing Bulgaria last among EU27 countries.21 The average for the EU27 was 32 percent. That same year, only 6.4 percent of value-added is in high-technology sectors, a number roughly equal to Romania’s but behind Slovenia’s 14 percent (see Figure 14).

100%

75%

50%

High-technology

Medium-high-technology

Medium-low-technology

Hungary

Slovenia

EU

Finland

Spain

Ireland

United Kingdom

Romania

0%

Estonia

25%

Bulgaria

Share of value added in manufacturing

Figure 14: The Bulgarian manufacturing sector is dominated by low-technology firms

Low-technology

Source: Eurostat (2005).

Note: Sectors are defined according to OECD classifications.

Furthermore, it appears that Bulgaria’s industrial structure is gravitating away from technologyintensive manufacturing. Employment in Bulgaria’s small high-technology sectors is growing slowly, at an annual rate of 0.3 percent in 2005, which compares poorly to Romania’s 9.4 percent growth rate. Employment is growing fastest in Bulgaria’s medium-low-technology manufacturing sectors, which experienced a growth rate of 5.4 percent in 2005. On the positive side, employment in the combined medium-and high-technology manufacturing sectors is growing faster than employment in low-technology sectors.22 Patents Patents are a useful measure of innovation since firms use them to protect their inventions from imitation. Nonetheless, it is important to note that firms also use other means to protect their inventions, such as secrecy, lead time advantages and the use of complementary marketing and manufacturing and marketing capabilities. Patents are also more widely used to protect inventions in some industries than others.23 Bulgaria lags behind most comparator countries in terms of patents granted by the US Patent and Trademark Office or patent applications to the European Patent Office.

This holds true whether these statistics are compared on a per worker basis or as a ratio to GDP (see

24

BULGARIA: Investment Climate Assessment

Figure 15). Bulgaria’s low patenting could indicate that domestic firms are engaged in technological catch-up rather than by pushing the technological frontier forward. But it could also partly reflect its industrial structure, which is heavily biased toward traditional low- and medium-technology sectors where firms typically compete more through process rather than product innovations, which can be protected by secrecy, or through low labor costs and flexibility of production.

patents per GDP patents per labor force

100000

1000

100

10000 1000

10

100 1

10

Estonia

Bulgaria

Slovenia

Romania

Turkey

Croatia

Malaysia

0,1 United Kingdom

1

Per million workers (log scale)

1000000

South Korea

Per million US$ of GDP [PPP] (log scale)

Figure 15: Bulgaria has been granted relatively few patents

Source: US Patent and Trademark Office; World Bank (2008c).

Note: Data are for 2005.

Technology Exports High-technology products have increased significantly as a share of Bulgaria’s total exports in recent years, growing at an annual average of 14 percent between 2001 and 2006. However, they still represent a smaller fraction of national exports (3.3 percent) than in any other EU country and about one fifth of the average for EU member states (see Figure 16). Moreover, the trade balance is negative in high-technology areas in Bulgaria. This implies that Bulgarian firms in the high-technology sector are likely to be engaged in low value-added assembly and transformation of imported hightechnology products, rather than designing and manufacturing these products from the ground up.

Bulgaria, has a high-technology export to import ratio of 0.4, the third lowest in the EU, about the same as in Romania and far lower than in Croatia and Estonia (both with a ratio of 0.8).

Figure 16: High technology constitutes a low, but growing, share of Bulgaria’s exports High tech exports in Bulgaria, 2001-2006

High tech exports, 2006

Turkey

2006

Bulgaria

2005

Romania

2004

Slovenia

2003

Croatia

2002

Estonia EU Average

2001

UK

2000

South Korea

1999

Ireland 0

1 2 3 4 high tech exports (% of total exports) Source: Eurostat.

Note: Data for Turkey are for 2005.

0 10 20 30 high tech exports (% of total exports)

25

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

Few of Bulgaria’s innovations are commercialized internationally. Receipts from international licensing agreements are contractual transfers of technology to other countries, and measure the prevalence of innovation in Bulgaria, the country’s ability to commercialize its technology abroad and the value placed on Bulgarian technology in global markets. Royalty and license receipts in Bulgaria are lower than in most other European countries (see Table 11). Moreover, they have not increased significantly on a per capita basis since 2000. Chile, which was at the same level as Bulgaria in the year 2000, now outperforms Bulgaria by a factor of two. This is in line with Bulgaria’s low level of patenting activity.

Table 11: Bulgaria royalty and license fee receipts are among the lowest in Europe Receipts per capita (US$)

Bulgaria

Croatia

Estonia

Romania

Slovenia

UK

0.7

16.5

4.0

2.2

8.2

220.9

Source: World Bank (2008c).

III. Innovation and Technology Absorption Activities Performance of R&D at the National Level R&D investment is a basic input for innovation, since it leads to the new or improved products, but it is also vital to developing technological absorptive capacity.24 From 1998 to 2006, R&D investment fell from 0.57 percent of GDP to 0.48 percent and is now much lower in Bulgaria than in any of the comparator countries in Figure 17 except Romania and FYR Macedonia. The EU’s Lisbon Strategy calls for increasing R&D from 1.9 percent of GDP in 2002 to 3 percent in 2010. Bulgaria cannot hope to meet this target in the next two years, nor would most countries at Bulgaria’s level of per capita income.

Figure 17: Bulgaria is investing too little in R&D to narrow the technology gap with the EU 4

Sweden

R&D over GDP (%)

Finland

3

Germany

Denmark Austria

2 Czech Republic

1

0

Croatia

Estonia

Hungary Portugal Turkey Lituania P oland Latvia Malta Romania Bulgaria Slovakia Macedonia

$5,000

$10,000$

15,000$

20,000$

UK

Slovenia Spain

Netherlands Ital y

Ireland

Greece

Cyprus

25,000

France Belgium

$30,000

$35,000

$40,000

GDP per capita (PPP US$)

Source: Eurostat; World Bank (2008c).

Note: Data are for 2005. For presentational purposes, Luxembourg is excluded from graph (GDP per capita is high with R&D below trend).

A comparison of R&D investments by national income levels shows that Bulgarian investments are not sufficient for long term technological catch-up. Countries typically invest more in R&D as they develop their industrial base and as consequently the opportunity costs of investing in R&D fall and private returns increase. Many highly-innovative countries such as Israel and Finland invested more than other countries at the same (low) income levels in their early stages of their catch-up with technologically advanced countries. Bulgaria is investing in R&D at lower levels than predicted by its GDP per capita, compared to EU member and candidate country averages (see Figure 17).

26

BULGARIA: Investment Climate Assessment

At current levels of investment, it is unlikely that Bulgaria will be able to narrow the technology gap with EU15 members in the medium term. Bulgaria’s low level of R&D can be partly explained by the country’s economic structure, which is dominated by sectors offering few technological opportunities. Nonetheless, R&D investment is lower than in Estonia, another country where manufacturing accounts for about the same share of GDP and with manufacturing sub-sectors at a similar level of technological intensity (see Figure 17). In countries where the economic structure offers few technological opportunities, increased investment in R&D can help firms move into higher-value added activities.

Although public sector and private sector funded R&D are complementary, privately funded R&D is more likely to respond to market incentives and is therefore more likely to lead to useful innovations. As noted in the ABC Report (World Bank, 2007a), private sector R&D expenditure is low—equal to only about 0.2 percent of manufacturing value added in 2005. This is comparable to Romania, but is far lower than in other EU accession countries such as Estonia and Slovenia (0.8 and 3.4 percent).25 As of 2005, only 28 percent of total R&D expenditures in Bulgaria originated from business enterprises, a smaller share than in any of the comparator countries in Figure 18, and only slightly higher than in 1997 (23 percent). With a 66 percent share of R&D funding, the government is the main source of R&D funding in Bulgaria. This is very different from most countries in the EU15, where Government funded R&D accounts for only about 30 percent of R&D or in highly innovative economies, such as South Korea (21 percent).

Figure 18: The productive sector accounts for a limited share of R&D expenditures in Bulgaria

75%

50%

Business enterprise

Government

Higher education

Bulgaria 1997

Bulgaria 2005

Croatia

Romania

Estonia

United Kingdom

Turkey

Spain

South Korea

0%

Ireland

25%

Slovenia

Share of R&D expenditures

100%

Other

Source: Eurostat; UNESCO Science & Technology Statistics.

Note: Data are for 2005 except for Bulgaria 1997.

Bulgaria is also relatively inefficient at turning R&D investment into applied results. Bulgaria spends more on R&D than most other European countries for each patent it generates (see Figure 19). Hence, its low patenting performance can be attributed to both its low level of investments in R&D and inefficiencies within its national innovation system. These systemic inefficiencies are endemic in countries with low levels of R&D expenditures, due to increasing returns to scale.

For technology followers such as Bulgaria, human capital in the research sector is vital in identifying, absorbing, adapting, imitating and upgrading foreign technologies. Only a small share of the labor force, however, work on R&D activities in Bulgaria (see Figure 20). The situation appears more favorable when accounting for income. In fact, Bulgaria has slightly more researchers than would be expected for its level of income, something that could help Bulgaria narrow the technology gap with the rest of Europe.

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

27

R&D/USPTO patents (PPP $ millions)

Figure 19: Bulgaria spends more on R&D for each patent it generates than in most other countries 200

Poland

Greece Estonia

Bulgaria

100

Latvia

Romania

Czech Republic

Portugal

Slovakia

Croatia

Cyprus

Spain Malta

Hungary

Slovenia Luxembourg G ermany Denmark Belgium France Ireland UK Austria Netherlands

Italy

0 0

1

R&D/GDP (%)

2

3

Source: Eurostat; World Bank (2008c).

Note: Data are for 2005. Lithuania and Turkey with high R&D/PTO and average R&D/GDP (above trend) and Sweden and Finland with high R&D per capita and low R&D per PTO patent (below trend) are excluded for presentational purposes. Trend line includes these points.

It is important to note, however, that the number of people involved in R&D has declined significantly since the 1990s and continues to do so. Between 1996 and 2004, the number of people working on R&D fell from 15,000 to 10,000.26 As a result, Bulgaria may soon find itself behind the comparator countries even when taking its lower income into account. Moreover, as is the case for R&D expenditures, technological catch-up will largely depend on Bulgaria’s ability to dedicate more human resources than competing technology followers on R&D, not comparable levels of resources.

Researchers per million workers

Figure 20: A dearth of researchers in Bulgaria compromises opportunities for technological catch-up 15000

Finland

12000

Sweden Denmark

9000

France Germany

6000

Estonia

Slovenia

Belgium Austria

Ireland Spain Netherlands Lituania Greece Czech Republic Slovakia Portugal Bulgaria Poland Italy Latvia Hungary Malta Croatia Romania Cyprus Turkey

3000

0 0

10,000

20,000

30,000

40,000

GDP per capita (PPP$) Source: Eurostat, World Bank (2008c).

Note: Data are for 2005. Luxembourg with very high income (US$70,000) and about 11,000 researchers per million (slightly below trend) is excluded for presentational purposes. Trend line includes this point.

In mid-2008, the Scientific Research Directorate of the MES announced a competition for a grant scheme to bring Bulgarian scientists living abroad back to Bulgaria. The scheme has a total budget of 800,000 BGN (about $583,000) and individual grants are for between 80,000 and 400,000 BGN. Therefore, less than 10 projects from universities or colleges could benefit from this program. As a result, the program will have only a minor impact.

28

BULGARIA: Investment Climate Assessment

Firm-level innovation relies on enterprises dedicating staff time to R&D. The share of R&D personnel in the enterprise sector in Bulgaria, however, is very low. R&D personnel represent only 0.07 percent of Bulgaria’s enterprise sector labor force, a significantly smaller share than in comparator countries (see Figure 21). In two EU accession countries, Slovenia and Estonia, respectively 32 percent and 61 percent of R&D personnel are employed by the private sector. In comparison, only 13 percent are employed in the private sector in Bulgaria. Moreover, the share of R&D personnel employed by the private sector has stagnated in the past decade and shows no signs of increase.

Figure 21: There are few workers in the private sector devoted to R&D in Bulgaria

0,75% 0,50%

Business enterprise

Government

Higher education

Turkey

Malaysia

Romania

Bulgaria

Croatia

Spain

South Korea

0,00%

Estonia

0,25%

Slovenia

share of labor force

1,00%

Private non-profit

Source: UNESCO Science & Technology Statistics; World Bank.

Note: 2004 data used for Romania, Spain, Malaysia, Croatia and Turkey. R&D personnel are counted as fulltime equivalent.

With support from the EU’s Structural Funds, the Operational Program “Competitiveness” includes a measure to subsidize the costs of R&D personnel in enterprises. The National Innovation Strategy also includes measures to promote the employment of young specialists in SMEs. A wellmanaged program to encourage the integration of innovation-related personnel in firms could have long-lasting effects on R&D and innovation in the private sector. International experience suggests that after participating in such programs, most companies gain a better understanding of the benefits of R&D and tend to extend the contract of their R&D staff beyond the duration of the co-financing program.

Innovation and Technology Absorption in Firms Introducing new product or upgrading products allows firms to be more responsive to fluctuating market conditions, find niches in higher value added market segments and is key to competing in a globalized economy where product cycles are becoming ever shorter. While Bulgaria’s industrial specialization influences its patterns of industrial innovation, it does not fully explain the low level of innovation found in Bulgarian firms. Bulgarian firms are less innovative than most of their European counterparts in the same industries. About 63 percent of Bulgarian firms in the metals and machinery sector introduced new or significantly improved products in the three years before the Enterprise Survey was conducted (see Figure 22). This compares to 68 percent of Romanian firms and 74 percent of Turkish firms, two regional competitors.

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

29

Introduced new or upgraded product in past three years (% of firms)

Figure 22: Bulgarian firms are less innovative than similar firms in other countries 100%

75%

50%

25%

0% Slovenia Croatia

Turkey

Ireland

South Korea

Romania Bulgaria

Source: World Bank Enterprise Surveys.

Note: 2007 data for Bulgaria and 2005 data for other countries. Data is shown for the metals and machinery sector for cross-country comparability.

This is consistent with data from the last Community Innovation Survey (CIS4), which shows that fewer Bulgarian firms have innovative activities than in any other EU countries Only 16 percent of Bulgarian firms had innovative activities compared to 49 percent in Estonia. This is true even taking into account Bulgaria’s low income level (see Figure 23).

Enterprises with innovative activities (%)

Figure 23: Few Bulgarian firms have innovative activities 80.00%

Germany

60.00% Belgium Estonia

40.00%

Czech Republic Poland

20.00%

Romania

Lituania Slovakia

Latvia Hungary

Denmark

Ireland

Austria

Sweden Cyprus Finland Portugal UK Italy Greece Netherlands Spain France Slovenia Malta

Bulgaria 0.00% 0

10,000

20,000

30,000

40,000

GDP per capita (PPP$) Source: Eurostat; World Bank (2008c).

Note: Data are for 2004. Luxembourg with very high income (US$70,000) and about 50 percent of enterprises with innovative activities (slightly below trend) is excluded for presentational purposes. Trend line includes this point.

Most firms in Bulgaria do not innovate or do so to only a minor degree and therefore are in danger of being left behind once factor costs increase. Some firms, however, have adopted an aggressive strategy for innovation. New or significantly improved products represent a higher share of turnover for these innovative firms than for similar firms in most other European countries (see Table 12).

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BULGARIA: Investment Climate Assessment

Table 12: Bulgarian firms that do conduct innovation are narrowing the technological gap Bulgaria Estonia EU Finland Romania Slovenia Turnover of new or significantly improved products new to the 8.5% 4.4% 6.3% 9.7% 7.1% 7.4% market as a share of total turnover for innovative enterprise Source: Eurostat, 2004.

Small firms are typically more vulnerable than larger firms to changing market conditions due to their more restricted access to finance. To survive, they must adapt quickly and develop or upgrade products. Despite this small firms in most countries find innovation more difficult than larger firms. This is the case in Bulgaria, where the fewer small manufacturing firms have introduced new products or processes than medium-sized or large firms (see Table 13).

Table 13: Small Bulgarian firms are less innovative than medium-sized and large firms Small Medium Large % of manufacturers that in the past three years have introduced new or improved Product 56% 72% 60% Process 44% 62% 57% % of Bulgarian firms that have acquired a new technology 27% 40% 39% in the past two years % of firms using a technology licensed from a foreign7% 13% 27% owned company Source: World Bank Enterprise Survey (2007).

While innovation is important to respond to customer needs, it often depends on the absorption of new technologies. So does reducing costs, replacing depreciated equipment and ensuring consistent process and product quality. Purchase of new hard or soft technologies is the most straightforward channel for technology absorption. Bulgarian manufacturing firms are not investing in new technologies at a rate which would allow them to narrow their technology gap with the rest of the EU. The Enterprise Survey shows that only 30 percent of Bulgarian manufacturing firms acquired a new technology in the past two years. A comparison of firms in the metals and machinery sectors shows that Bulgarian firms are among the laggards in terms of new technology acquisition (see Figure 24).27 The fact that Bulgaria is slightly ahead of South Korea, should be taken as a sign that it is catching up, albeit very slowly, with technology leaders. However, Bulgarian firms are running the risk of being left behind other technology followers such as Romania and Turkey, which are adopting new technologies at a quicker rate (see Figure 24). Moreover, small firms are acquiring comparatively fewer new technologies in Bulgaria and are more vulnerable to fall even further behind their regional competitors than medium and large counterparts (see Table 13).

Figure 24: Bulgarian firms are falling behind technologically

Acquired new technology in past three years (% of firms)

100%

75%

50%

25%

0% Slovenia

Croatia

Turkey

Ireland

Romania Bulgaria

South Korea

Source: World Bank Enterprise Surveys.

Note: 2007 data for Bulgaria and 2005 data for other countries. Data is shown for the metals and machinery sector for cross-country comparability.

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

31

IV. Adoption of Foreign Technology Trade, licensing and FDI are three important channels for adopting new technologies from abroad.28 Adoption of foreign technology is particularly important for small countries like Bulgaria with a limited pool of researchers to generate new technologies. Adopting technologies from abroad is less costly, less risky and quicker than developing new technologies domestically.

Trade Trade can act as a channel for technology transfer through both imports and exports. Technology can be transferred to domestic firms through imported capital goods with embedded knowledge.

Technology can also be transferred through exports through interactions with global buyers. The effectiveness of both channels depends on the technological capacity of trade partners and the types of goods that are traded.

Figure 25: Bulgaria imports fewer high-technology products than would be predicted by its income level High technology imports (% of total)

35

Malta

30

Ireland

25 Netherlands

20

Hungary Czech Republic

15 Slovakia Poland

10

Romania

5

Macedonia

Finland Sweden

Portugal Spain Cyprus Italy

Latvia Estonia Croatia Lituania

Bulgaria

Germany UK France

Slovenia

Greece

Denmark Austria

Belgium

0 0

10,000

Source: Eurostat; World Bank (2008).

Note: Data are for 2006.

20,000 30,000 GDP per capita (PPP$)

40,000

Because most imported goods come from technologically advanced countries, Bulgaria could absorb foreign technology through imports. But the technological content of most of its imports is not high. Imported capital goods from technologically advanced countries were an important source of new technology for firms from South Korea during that country’s industrialization process.

Bulgaria could reap similar benefits as roughly half of Bulgarian imports come from technologically advanced EU15 countries. Given Bulgaria’s comparative advantage in low-skilled labor compared to the EU15 countries, goods imported from those countries are mostly capital or skills intensive and embody a relatively high level of technology. However, a closer examination reveals that few are in technology intensive sectors. In fact, high-technology products represent a lower share of total imports in Bulgaria than would be predicted its income level (see Figure 25). Further, it is not clear that Bulgarian firms have the technological absorptive capacity to receive the maximum benefit from these imported goods, given that innovation and R&D, both of which contribute to building absorptive capacities, are low. Importing capital goods is most effective when firms have the ability to reverse engineer the goods through a supportive infrastructure of research institutions and universities, as was the case of Korea Institute of Science and Technology (KIST) in South Korea, or through high levels of technological absorptive capacities. Bulgarian firms lack the human capital and support structures to facilitate technology transfers in this way.

Exports can serve as important channels for technology absorption when suppliers transfer knowledge from buyers in technologically advanced countries. International experience shows that knowledge transfer is greater in value chains for higher quality products and thus those involving more technologically sophisticated processes or inputs (see Box 1). Furthermore, exporting increases

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BULGARIA: Investment Climate Assessment

competitive pressures to absorb new technologies and introduce new or upgraded products and processes. Exports have the potential to act as channels of technology transfer from foreign buyers in Bulgaria, where more than half of exports were destined to more technologically advanced EU15 economies in 2007.29 However, most of Bulgaria’s exports are in low-technology sectors such as garments, food and raw materials, which do not target high-quality market segments. As noted earlier (see Figure 37), only a small share of Bulgaria’s exports concern medium and high-technology segments, where relationships with foreign buyers can be expected to be more sustainable and based on knowledge sharing.

Box 1: Learning through global buyers in Brazil’s footwear industry Buyers in global value chains can play an active role in transmitting technical and organizational knowledge to their suppliers. Local producers can benefit from buyers’ knowledge on improving production processes, attaining consistent product quality, developing new products and decreasing delivery time. In the 1970’s when Brazil’s shoe industry was still at an early stage of development, international buyers maintained a substantial technical staff in Brazil and played a key role in helping firms reach international quality and delivery standards. Experience from Brazil’s Sinos Valley footwear cluster shows that producers in higher-quality market segments were able to forge much tighter relationships with global buyers or transnational corporations.

This is because buyers in quality-driven value chains needed to engage in intense communication with their suppliers, instruct them on specifications and assist them with technology transfer to ensure that they are producing good quality products. Having invested in their suppliers, these buyers were then unlikely to change partners for the sake of lower short-term prices since they would face high switching costs. Furthermore, firms that had benefited from buyers in higherquality export markets were able to use their knowledge to penetrate new export markets with their own brands and designs.

Source: Humphrey and Schmitz (2000); Schmitz and Knorringa (2000); Vargas(2003); Monge-González and others (2005).

Licensing Another important way of getting access to new technologies is through licensing agreements.

Since firms license technologies that are patent protected, licensing shows that these firms are using relatively advanced technologies. However, there are limitations to licensing as a way of transferring technology. Licensing only embodies the codified part of a technology and may not improve technological capability significantly unless the firm licensing the technology has already accumulated tacit knowledge. In Bulgaria, as in other countries, licensing is less useful for SMEs because they find it hard to identify and negotiate collaborative agreements with foreign technology suppliers (see Table 13).

Figure 26: Bulgaria licenses few foreign technologies but is slowly catching-up Licensing in Bulgaria, 2000-2005

Licensing, 2005 Turkey

2005

Romania 2004

Bulgaria

2003

Estonia Croatia

2002

Malaysia

2001

Slovenia Korea, Rep.

2000

United Kingdom $0

$3

$6

$9

$12

$0

$40

Per capita license and royalty payments (US$)

Source: World Bank (2008c)

$80

$120

$160

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

33

Licensing and royalty payments from Bulgaria are far smaller than in most of the comparator countries, many of whom also have economies with large numbers of small firms (see Figure 26).

For example, firms in Croatia spent four times more than firms in Bulgaria on licenses and royalties on a per capita basis in 2005. Nonetheless, Bulgaria is catching up, having increased its licensing and royalty payments by almost a factor of ten between 2000 and 2005, surpassing both Turkey and Romania over this period.

Foreign Direct Investment FDI can also be an important source for foreign technology. Foreign investors often introduce innovations related to product, process and management techniques from their home countries to their domestic subsidiary. Technologies introduced to the subsidiaries often spillover to other domestic firms, through backward and forward linkages, imitation, and worker mobility.30 FDI contributed to rapid growth in countries such as Singapore and Ireland, where it brought tangible assets in the form of equipment and intangible assets in the form of training and skills. Nonetheless, it is important to note that in general, FDI will be most beneficial if local firms have the absorptive capacity to assimilate and use foreign practices and technologies.

FDI inflows in Bulgaria have dramatically increased in the past five years; reaching levels that are high by international standards (see Chapter 1). However, only a small and diminishing amount and share of FDI flowing into Bulgaria concerns the manufacturing sector. This is the sector where it has the most potential to facilitate technology absorption.

Moreover, Bulgaria compares unfavorably to other countries in the region in terms of the number of manufacturing firms with foreign ownership. The Enterprise Survey shows that only 5 percent of manufacturing firms in Bulgaria had any foreign ownership, compared to 13 percent in Romania and 33 percent in Estonia. Joint ventures, which have often been credited for being an effective form of technology transfer through FDI, since they involve a local partner, are particular uncommon in the Bulgarian manufacturing sector. There are almost three times more foreign joint ventures in Croatia and Estonia as there are in Bulgaria (see Table 14). Low levels of FDI are impeding Bulgaria firms from narrowing the technological gap with the EU. Moreover, Bulgarian firms’ low level of technology absorptive capacity reduces Bulgaria’s potential to leverage FDI for technology transfer.

Table 14: Joint ventures play a limited role in technology transfer to Bulgarian manufacturing firms Bulgaria Croatia Share of manufacturing firms which agreed Joint Ventures with a foreign partner in the past 3 years.

3%

8%

Estonia 8%

Ireland Romania Slovenia 11%

5%

4%

Source: World Bank Enterprise Survey 2007; BEEPs 2005.

Note: 2007 data used for Bulgaria, 2005 data used for all other countries.

V. Financial Resources for Innovation and Technology Absorption Technology absorption and innovation will take place only when firms have the resources to finance these activities. As well as using internal resources, firms can use different types of financing depending on the market-readiness of the technology and the growth stage of the company. In most countries, public funding and, to a lesser extent, funding from large corporations finances basic or long-term research with no immediate market applications and high positive externalities.

Applied research is typically funded by a mix of public and private sources. In most countries, and particularly in transition countries, a major funding gap occurs in the early stages of technology commercialization. At this stage, a startup firm needs to seek seed capital from business angels. As the company’s prospects improve, venture capital funds can provide the required capital. As the company grows and reaches maturity, traditional forms of equity and bank loans become available.

34

BULGARIA: Investment Climate Assessment

Private Sources of Finance There are few sources of finance for technology adoption and innovation in Bulgaria, particularly for SMEs. About 74 percent of Bulgarian firms in the Enterprise Survey used their own internal resources as the main source of financing for technology adoption and innovation, and about 23 percent using bank loans. Smaller firms that are often less profitable, less transparent, and are less likely to have collateral will often have only limited access to these sources of finance. Although bank financing has become more readily available to Bulgarian firms in the past few years, longterm financing, which is important for long-term R&D projects, is far less available than short-term financing for working capital needs (see Chapter 8).

There is no venture capital market in Bulgaria to close the gap between research and technology commercialization, although funding is available for more established firms. Venture capital (VC) is crucial to finance start-up technology-based businesses in their initial loss-making phases. At the startup phase, new technology-based firms have few other ways to finance commercialization.

It is only when they reach maturity that they can use profits, public share purchases, institutional investors, bank loans and public grants or subsidies to finance their operations. VC is useful for innovative startups in that it is usually coupled with innovation management assistance, which increases the chances of reaching the commercialization stage. In Taiwan, Korea and Israel the state played an active role in the provision of VC. In Israel, the government created the first VC fund in 1993, acting as the core investor, thereby attracting other funds. By 1997, the Government was exited the VC industry, which had become a major source of funds for technology-based companies.

Box 2: Government support for VC funds in Taiwan and Korea The Korean Government has a long history of support for the VC industry through co-investment with private investors in VC funds, starting in the 1970s and 1980s with the Korea Technology Advancing Corporation and the Financial Assistance to New Technology Businesses Act in 1986. The government has been and continues to be the largest supporters of VC funds in Korea, contributing over 30 percent of the capital in new VC funds in 2004. The Korean strategy for promoting VC firms includes multiple instruments—tax incentives; participation as a limited partner; credit guarantee program (less successful); and establishment of a bank, later privatized, specialized in R&D loans. Both the establishment of VC firms and the investment resources in the VC pool increased dramatically after 1997, after the adoption of the act on Special Measures for the Promotion of Venture Businesses. The government co-investment approach is viewed by many as a critical catalyst to the development of the VC market.

In Taiwan, the government has also actively supported the VC industry by using tax incentives, including through tax credits or lower tax rates, to encourage investors to invest in equity funds.

Taiwan allowed investors in qualified VC funds a credit of 20 percent of their investment to offset tax liabilities, proportionate to actual investments by the VC companies. Taiwan’s tax incentive was very effective in encouraging domestic investors, especially large companies, to invest in VC funds, resulting in the establishment of a number of local VC funds. Eliminating the tax incentive, however, has had a very negative effect on the VC industry in Taiwan, with an immediate decline in funding through VC. Companies now prefer to invest directly rather than through VC funds.

Source: Goldberg and others (2006).

There are currently no VC funds operating in Bulgaria and no significant signs of business angels to provide seed funding for early-stage startups prior to VC funding.31 Two likely reasons for the absence of these are a shortage of management skills required for funds and a lack of an appropriate stock exchange to facilitate exits via initial public offerings for small innovative firms. The latter is essential to VC, since venture capitalists will only invest if there is a proper exit strategy from which they can profit from their investments.

The newly adopted Bulgarian Development Bank Act envisages the establishment of a large VC fund to help SMEs. The potential for this to create an incentive for other VC funds in the country is yet to be evaluated. In addition, the OP Competitiveness includes the establishment of holding funds to invest in seed and VC funds. The OP also includes a â‚Ź1 million measure to develop business angel networks in Bulgaria to provide channels of communication between private investors (business angels) and entrepreneurs seeking seed funding. Angel networks can be challenging to set up, however, as many angels are independent and reluctant to join a formal network (European Commission, 2002).

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

35

Public Financial Support Public funding for technology adoption and innovation in firms is negligible in Bulgaria, although two Government programs could help to bridge this gap in the near future. In 2004, a smaller share of innovative Bulgarian firms benefited from central government funding for innovation than in any other EU member country (see Figure 27). Only 1 percent of Bulgarian innovative firms received public support versus 43 percent in Norway, 8 percent in Estonia and 3 percent in Romania.

However, the situation is likely to improve, as two government programs are providing increased funding for innovation and technology adoption. The Ministry of Education and Science offers competitive research funding through the National Science Fund (NSF), although this is mainly targeted at research institutions. The Ministry of Economy and Energy offers matching grants for R&D to enterprises through the newly-created National Innovation Fund (NIF)

50% 40% 30% 20%

Bulgaria

Romania

Slovakia

Lithuania

Germany

Estonia

Denmark

Spain

Czech

Italy

Hungary

Finland

0%

Netherlands

10%

Norway

% of firms receiving public funding for innovation

Figure 27: Few innovative firms receive funding from the central government in Bulgaria

Source Eurostat.

Note: Data are for 2004.

Most Government funding for research in Bulgaria is provided through institutional funding to research institutes and universities. Competitive funding ensures that funding is allocated based on clear and transparent merit-based criteria and allows funding to go to the best performing research groups. In contrast to institutional funding, competitive funding can also be open to private enterprises. While the NSF and NIF are increasing the amount of competitive R&D funding available in Bulgaria, as noted in the ABC Report (World Bank, 2007a), institutional transfers for research institutes and universities still account for the largest share of the national R&D budget (see Table 15).

Competitive funding only accounts for 20 percent of government funding for research. This ratio is often reversed in OECD countries and other highly innovative countries, where institutional funding constitutes a small share of total research funding. In 2006, only 13 percent of Slovenia’s national research budget was allocated through institutional transfers, the rest being awarded competitively, mostly through the Slovenian Research Agency. A survey of large European research institutions showed that they tended to receive roughly one-third of their funding as core funding, another third as competitive public funding, and another third from contract research (European Association of Research and Technology Organizations, 2005). The ratio of competitive funding to institutional funding in Bulgaria is too unbalanced to allow the strategic goals of research institutes and universities to respond quickly to national research priorities and guarantee that funds are used in the most effective way.

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BULGARIA: Investment Climate Assessment

Table 15: Most government funding for innovation is in the form of institutional transfers Funding Type Competitive Funding Beneficiary 2007 R&D budget (€ million)

Institutional Transfers

National National Bulgarian National Center Ministry of Science Innovation Academy of for Agrarian Universities Defense Fund Fund Sciences Sciences 7.6

6.1

Total: 13.7

1.0

34.8

2.3

14.4

Total: 53.5

Sources: BSMEPA, NSF, ERAWATCH. Notes: National Center for Agrarian budget estimate is based on 2006 data. University estimate based on proportion of university budget to be spent on R&D according to the Law on Higher Education; however, universities are thought to spend significantly less on research.

The National Science Fund (NSF) runs several competitive funding program modules mostly in accordance with international good-practices but allocates a very minor share of total public research funding. The NSF, administered by the Scientific Research Directorate of the MES, was created in 1990 and has emerged into a modern competitive funding mechanism for research. Competitions are held on an annual basis, mostly awarded on scientific merit rather than national research priorities.32 About two-thirds of R&D grant beneficiaries are research institutes from the Bulgarian Academy of Sciences. The rest consist of universities and, to a very minor extent, enterprises.

One program module is specifically focused on promoting research in universities, which perform little R&D in Bulgaria. Another small module targets SMEs collaborating with research institutes and universities. Ad-hoc committees of national and international scientific experts review and recommend funding applications, and provide annual project assessment reports to the MES. The NSF itself is reviewed periodically by independent international experts. In 2007, the NSF’s budget was €7.6 million, an increase from the €6.6 million it received from the MES in 2006. Despite a steady increase throughout the years, this budget is still very small by European standards. In comparison, the budget of the Slovenian Research Agency was €141 million in 2006.

One consequence of this small budget is that NSF’s average grants are small, at around €10,000 for thematic grants. Given the lumpy nature of research and the high fixed costs for equipment, research funding agencies in many countries have favored increasing research grant size at the cost of funding fewer projects.

The National Innovation Fund (NIF) provides a growing and much-needed source of funding for innovation in the productive sector. The NIF became operational in 2005 through the MoEE’s National Innovation Strategy. It is managed by the Bulgarian Small and Medium-Size Enterprises Promotion Agency (BSMEPA). The NIF is the only Bulgarian program specifically focused on increasing innovation in enterprises. It provides matching grants for two types of programs: feasibility studies for innovative projects, funded at 50 percent of their costs, and applied research projects, funded at 25 to 50 percent of their costs, for a subsidy up to around €250 000. In practice, it appears that some of the projects funded could be more closely described as technology absorption than innovation. Firms can apply for funding alone or the grant can cover 10 percent more of the costs if they apply in consortia with other firms, research institutes and universities. SMEs are given preference over large firms. In practice, almost all applicants are SMEs and around 40 percent of firms apply jointly with researchers. In its first two years, the NIF had funded approximately 220 projects. In 2008, the NIF’s budget will be 20mln BGN (€10 million.), and according to the National Innovation Strategy it is expected to increase gradually up to 52mln BGN (€26 million) in 2013.

Although this program represents an important measure for increasing innovation in SMEs, its current impact is limited to funding 100 to 150 innovative firms per year. The NIF has not yet been subject to an independent assessment and it is not clear that the agency will have the capacity to increase the number of grants at the predicted levels.

Some aspects of NIF could be improved to operate closer to international best practices. As in the case of the NSF, NIF grants are recommended by an Evaluation Committee consisting of external experts, but unlike the NSF, the NIF does not make use of international experts. In a country as small as Bulgaria, international evaluators can ensure the independence of an evaluation committee.

Funding is based on reimbursements of expenditures, so firms must wait for disbursement until they

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

37

have completed their projects. This delay in the disbursement process, combined with a limit of 50 percent of co-financing, places considerable constraints on smaller firms with insufficient liquidity to cover the costs of research up front before they are reimbursed. In some cases, companies have experienced long delays in receiving NIF funding after project completion. In realization of these constraints, many innovation programs for SMEs cover much more than 50 percent of expenses.

The Tekes agency in Finland, offers matching grant to funds up to 65 percent of costs, and Enterprise Estonia covers up to 75 percent of costs. NIF calls for funding are held on a periodic basis, although there is no fixed term for calls. Given that the funding application process is rather demanding and that SMEs operate with limited spare capacity, it can be difficult for some firms to prepare the application in a timely manner without sufficient advanced notice.

Tax incentives can be used to support R&D through high and accelerated depreciation rates for R&D equipment or tax credits on R&D expenditures. They are best-suited for innovative companies that have reached as stage at which they are generating revenue but are less useful for start-ups with no revenue and a high risk of failure. To partially offset this limitation, some countries offer schemes to carry R&D costs forward, although these are not much of an incentive in countries with high inflation or for startups who never reach the revenue-generating stage.

Bulgaria has recently adopted amendments in its tax laws that favor R&D, but these are likely to benefit only a very limited number of firms. Amendments in the Law on Value Added Tax and in the Law on Corporate Income Tax provided tax refunds to companies exporting software and increased the depreciation rate for long-term assets linked to R&D activities. The conditions for this depreciation are quite restrictive in that R&D must represent the main activity of the firm and should be implemented by a research institute or university. It is very unlikely that many Bulgarian firms meet these requirements.

As a result, current tax incentives for R&D are very limited, and unlikely to have any effect on innovation in Bulgaria. That said any new corporate income tax incentive scheme introduced in Bulgaria could face a number of challenges. At 10 percent, the corporate income tax is already very low by regional and global standards and the marginal impact of any further tax reductions is likely to be limited. Furthermore, without proper enforcement, firms can abuse tax credits by mislabeling other activities as R&D. Tax incentives schemes are typically complicated to operate and any such schemes in Bulgaria would require strong coordination between the tax collection authorities and the ministry or agency responsible for implementing the scheme.

There is no comprehensive process in place to measure the impact of government funding for research and innovation. Independent evaluations ensure that public funding for research and innovation is spent on effective projects, programs and institutions. The periodic evaluation of the National Science Fund provides an excellent example of good practice in Bulgaria. No other program or institution receiving public funding has been independently evaluated thus far, nor has Bulgaria’s participation in the EU’s Framework Programs for research. In Germany, the individual institutes of the Max Planck Society, an institute similar in mission and structure to the Bulgarian Academy of Sciences, undergo scientific evaluations by independent Scientific Advisory Boards every two years. At a higher level, the German Government requests international commissions to conduct system evaluations of the Max Planck Society.

EU Funding Bulgaria’s recent accession to the EU should provide opportunities to significantly increase funding available to domestic researchers and innovative firms. EU support for R&D and innovation is provided mainly through the Seventh Research Framework Program, the Competitiveness and Innovation Program and the Structural Funds.

In Bulgaria, the EU’s Framework Program will mainly benefit research institutes and universities.

The EU’s Seventh Framework Program for Research and Technological Development (FP7) provides research funding through competitive calls for proposals. It has a total budget of €50 billion between 2007 and 2013, a substantial increase from its predecessor, FP6. FP7 funds typically reimburse up to 50 percent of R&D activities. This has two implications for Bulgaria: (1) researchers must be able to match FP7 financing with national sources of funding and (2) since a portion of the FP7 grants is only disbursed at project completion, researchers must cover an important share of project costs in the short term, again through national sources of funding. These two conditions may be problematic

38

BULGARIA: Investment Climate Assessment

given the scarcity of public funds for Bulgarian researchers. Bulgaria will face other challenges in benefiting from FP7. Since FP7 funding is competitive and there are no fixed national allocations, it is more accessible to countries with highly developed research infrastructures. Nonetheless, since the largest component of FP7 funds is earmarked for transnational research consortia, it does offer opportunities for countries with less competitive research systems to partner with other countries in search of geographical balance. A small component of FP7 is reserved for research in collaboration with SMEs. However, it is unlikely that the vast majority of Bulgarian SMEs have the capacity and resources to engage in the complex and time-consuming proposal preparation process.

Instruments under the EU’s Competitiveness and Innovation Framework Program (CIP) may provide some limited funding opportunities for innovative Bulgarian firms. The CIP aims to foster the competitiveness of European enterprises over the 2007-2013 period. Funding is determined on the basis of competitive calls for proposals which, like FP7, do not include fixed national allocations.

One CIP scheme with a budget of €1.1 billion will offer financial instruments to cover market gaps in the supply of debt and equity finance to SMEs, and will become progressively operational during 2008. These programs will be managed by the European Investment Fund and implemented via financial intermediaries or specialized funds. The CIP also includes a €430 million programs for matching grant funding of first applications or market replication of innovative or eco-innovative techniques, products or practices of European relevance. While the financial instruments program has the potential to provide much needed risk capital for early stage firms it is unlikely that most of Bulgaria’s SMEs will have the technological capacity to compete for co-financing offered under CIP in the short-term.

EU Structural Funds will present Bulgaria with significant opportunities for increasing its funding to research and innovation. As EU regional policy increasingly focuses on the knowledge economy, EU investments in research and innovation under the Structural Funds are expected to grow from €13 billion between 2000 and 2006 to above €99 billion between 2007 and 2013, or 29 percent of the total funding envelope (European Commission, 2008). Structural Funds are distributed among the Member State by a fixed key.33 In the case of Bulgaria, funding and co-funding programs have been defined in six Operational Programs (OPs) covering the 2007 to 2013 period. Three out of Bulgaria’s six OPs include research, innovation or technology absorption. By far the largest amount earmarked for promoting this area is in the OP for Development of the Competitiveness of the Bulgarian Economy.

The OP Human Resources Development and OP Regional Development also include funding for activities explicitly connected to innovation, but in much smaller proportions. The total budget of the OP Competitiveness is of €1.16 billion, which includes €988 million of Community assistance. Of the total, roughly €709 million34 have been earmarked for areas related to innovation or technology absorption and €246 million specifically to grants for innovation, technology absorption and research projects and infrastructure.35 Implementation of a variety of grant schemes for all stages of innovation and technology commercialization will be implemented by the BSMEPA and awarded to SMEs, public institutions and non-governmental organizations.

Chapter3: INNOVATION & TECHNOLOGY ABSORPTION

39

VI. Soft and Hard Infrastructure for Innovation Knowledge Transfer Intellectual Property Rights (IPR) Bulgaria has made progress in the field of protection of IPR, but Intellectual Property (IP)-related crime remains a continuing challenge for innovation and technology diffusion. Adequate IPR legislation and protection promote innovation by guaranteeing that the gains from investments in R&D can be internalized. They also promote diffusion of foreign technologies since the patent owners do not run the risk of seeing the license conditions violated.

Intellectual Property Rights Index (high values mean more protection)

Figure 28: Weak enforcement of intellectual property rights hinder innovation in Bulgaria 9

6

3

0 United Kingdom

South Korea

Spain

Malaysia Chile

Turkey

Bulgaria Romania

Source: Thallam (2008).

Bulgarian IPR legislation has been aligned with the acquis since amendments to the Law on Patents, the Law on Trade Marks and Geographical Indications and to the Law on Industrial Design were adopted in July and August 2006. While legislation is good, enforcement of IPR legislation is now the main problem. The IPR Index, produced by the International Rights Alliance, measures the level of IPR protection at the national level. The index considers IPR protection, patent strength, copyright piracy rates and trademark protection. Bulgaria ranks 55th out of 115 countries on the 2008 IPR Index (see Figure 28), scoring particularly poorly on IP protection (90th out of 115) and slightly better on copyright piracy (62nd out of 115), but extremely well on patent strength (11th out of 98). This was a significant improvement for the last component since 2007 (37th out of 70.

Software piracy discourages innovation in the information technology (IT) sector in Bulgaria.

Software piracy rates, at 71 percent, are more than twice EU or world averages (see Table 13), and result in US$ 41 million of losses to the software industry in 2005. Further, software piracy rates have not decreased and Bulgaria’s share of worldwide software piracy losses actually increased from 0.09 percent to 0.12 percent from 2003 to 2005.36 Bulgaria has taken steps to reduce IPR infringement, including a national awareness campaign started in August 2006, meetings with industry associations and training of involved relevant ministries, the patent office, prosecutors and customs officers.37 Table 16: Bulgarian software piracy rates remain among the world’s highest Bulgaria World

Piracy rate (2005)

Decrease in piracy rate (2002-2005)

71%

0%

35%

1%

Source: Business Software Alliance (2006).

R&D Institutes The Bulgarian Academy of Sciences (BAS), an autonomous state-funded institution, performs most R&D in Bulgaria. Its 69 institutes, laboratories centers and museum function as relatively independent units, each a legal entity of its own. BAS’s organizational structure is close to that of the Max Planck Society in Germany, consisting of a network of autonomous institutes which are represented at the central level by a Senate or General Assembly and a President.

40

BULGARIA: Investment Climate Assessment

BAS has restructured and downsized since 1991, reducing the number of scientific units by a third, decentralizing and halving its workforce. Nonetheless, with 8,100 employees, it employs about half of Bulgaria’s R&D workforce,38 is responsible for over half of the country’s scientific publication and patent output (BAS 2006) and consumes more than half of government R&D funding (see Table 15).

Under a special status, BAS can present its annual budget directly to the Ministry of Finance (not to an individual ministry). The BAS budget is distributed internally to the different scientific areas based on research priorities determined by the BAS General Assembly. As such, BAS’ activities are not bound by the draft of the National Strategy for Research and Development and the National Innovation Strategy.

BAS has solidified its financial position in recent years, increasing its revenues from nongovernment sources. But its budget is spread thin and little is used for new investment. State subsidies have been steady in recent years, with the exception of a significant increase from €35 to €42 million from 2007 to 2008. These funds are mainly used to cover salary, administrative and building maintenance costs, and given the high number of personnel, result in per capita funding of only €3,904 in 2006. Limited funds are used for acquiring tangible assets. New investments are mostly financed through project-based funding, mostly from abroad (EU or NATO), which have steadily increased in recent years and now account for one third of BAS’s budget.

In spite of the increase in non-state-budget funding, less than 5 percent of BAS’ budget goes towards investments in tangible assets. In comparison, 14 percent of the budget for the Max Planck Society’s basic research institutes and 19 percent for the Fraunhofer Society’s applied research institutes, two of Europe’s most reputable research organizations, is used in this way.39 With few new investments in infrastructure and equipment, there is a risk that BAS will fall further behind the technological frontier, compromising its ability to conduct both basic and applied research in the wide range of fields it is involved in. Structural Funds, through the Operational Program “Competitiveness” (see Section V), include a measure for the modernization of applied research equipment. This measure should be useful provided that funds are granted competitively and based on market demand.

Institutional funding to the BAS is not granted on the basis of clear performance benchmarks or a general strategic plan. As noted above, the BAS receives institutional or “core” funding for fixed costs based on a budget presented to the Government. This is not a model commonly found in bestpractice research institutions. Typically, institutional funding is provided either conditionally, based on an agreed multi-year plan of activities, or on performance-based mechanisms, often related to the success of working with industry. Multi-year performance-based mechanisms, found notably in Germany and France, have the advantages of ensuring a stable and predictable income stream, important for long-term planning of research, and ensuring the practical relevance of the institute’s activities.

Many countries have found that a good way to ensure the long-term competitiveness and sustainability of a research institute is to allocate a small portion of its institutional funding to the development of capabilities through strategic research activities, usually as part of a strategic plan agreed upon with the government. This allows the institute to remain competitive in the long run.

In the case of a decentralized organization such as the Fraunhofer Society in Germany, central management uses a similar core funding process to allocate funding to individual institutes. In Bulgaria, it may be difficult to negotiate a strategic or performance–based mechanism for core funding since BAS presents its budget directly to the Ministry of Finance, not to a body responsible for research and innovation policy. In Germany, for example, the Federal Ministry of Education and Research is responsible for allocating institutional funding to the national research institutes, including the Max Planck Society and the Fraunhofer Society.

There are no genuine industrial research and development institutes (IRDIs) 40 focused on contributing to short-term private sector competitiveness in Bulgaria. The specialized IRDIs operating under various government Ministries were privatized in the 1990’s and later dissolved, unable to adapt to a market economy. While a number of BAS institutes, such as the Institute of Physical Chemistry, are successfully carrying out projects with industry, these tend to be with larger – often foreign – organizations conducting advanced research. Domestic SMEs operate at a level too far from the technological frontier to find relevant support at BAS institutes and do not have sufficient financial resources to invest in collaborative R&D activities.

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Although BAS institutes produce a large number of patents, most of these inventions are not responses to specific market demand. BAS’ incentive structure rewards scientific performance such as publications rather than industry contracts, and the organization’s low salaries make it unattractive to personnel with relevant industry experience. Industry experience is now considered vital for researchers at most successful R&D institutes. It allows the institutes to understand the latest technologies and practices in use in industry and to adapt their research based on market needs.

It also creates personal linkages between research and industry. This, however, requires flexible human management policies and financial resources. A number of countries operate programs to increase mobility between research and industry, including the Casimir program managed by the Netherlands Organization for Scientific Research (NWO). In 2005, BAS created a new unit, the Center for Innovation, to coordinate the establishment of technology transfer units in some of the more innovative institutes. Although this first step is likely to contribute to an increase linkages between BAS and domestic firms, deeper changes within the institutes, such as structured marketdriven processes to identify and fund relevant technologies, will be required if they are to meet the needs of domestic firms.

Box 3: The role of industrial research institutes The share of SMEs collaboration with public research institutes varies from country to country, depending on the technological maturity of the market, industry structure and supportive policies among other factors. Surveys of mostly OECD countries show country averages of approximately 3 percent of SMEs, with some as high as 10 percent (Finland), collaborating with government research institutes. These proportions are high considering that they involve firms in a broad range of sectors, including service sectors not typically associated with technology adoption or innovation (Organization for Economic Co-operation and Development, 2007a).

When firms do collaborate with research institutes, these are often specialized industrial R&D institutes (IRDIs). In many countries, IRDIs occupy an important role in the national innovation system, drawing from national and international industrial and scientific knowledge to provide support to industry. They acquire, maintain and supply technologies and technology-related services to firms that cannot access them in-house. In some newly-industrialized economies they were initially used to address existing gaps in the national innovation systems. These include KIST in South Korea, ITRI in Taiwan and HKPC in Hong Kong (Arnold and others, 1998).41 In contrast to universities and basic research institutes, IRDIs carry out little advanced research, and complement ‘hard’ technological development activities with ‘soft’ activities such as testing, troubleshooting, consultancy, training, seminars and standards and certification.

IRDI clients often include small firms which lack the capability and market intelligence to identify their own technological, organizational and managerial needs. However, supporting this market segment requires specific skills in marketing and business that many universities and research institutes are unlikely to have. Many IRDIs, such as CITER in Spain and HKPC in Hong Kong, are explicitly organized to serve this market. Moreover, the SME market is typically fragmented, so even successful market-driven IRDIs rely on government programs to support SME demand.

Higher Education Institutions Education and research are poorly integrated in Bulgaria and universities tend to focus almost exclusively on teaching. All 42 universities in Bulgaria conduct research, although the three largest conduct the bulk of it. The 1995 Law on Higher Education stipulates that 10 percent of state subsidies for universities should be directed towards research. In reality, much less is thought to be spent on research. As a result, the research potential of the higher education sector is under-exploited. In 2005, this sector employed 21 percent of R&D personnel in Bulgaria but only conducted 11 percent of R&D (UNESCO). In other countries such as Spain, Estonia and Slovenia this ratio is much closer to unity. Moreover, universities often play a key role in supporting innovation and technology absorption in the private sector (see Box 4).

Several obstacles stop Bulgarian universities from increasing the quality and quantity of their research activities. The most important challenge is the decline in the quality of higher education in the past decade (Organization for Economic Co-operation and Development, 2004). Added to this, the university faculty body is ageing and low salaries and outdated career advancement policies making it difficult to attract young staff. Faculty members also tend to be overloaded with teaching, leaving them little time for research. This is compounded by poorly funded libraries, which make it difficult for researchers to keep up with the latest development (Organization for Economic Cooperation and Development, 2004). Finally, even the largest research performing universities have relatively small graduate programs, limiting the number of students who can contribute to research.

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Although the number of enrolled doctoral students has grown in recent years, relatively few students enroll in science and engineering doctoral programs in Bulgaria (see Figure 29).

Box 4: The role of universities in supporting innovation and technology absorption Universities play an important yet complex and evolving role in the national innovation system of most OECD countries. While education and research were kept apart from one another by brick walls in centrally-planned economies, their tight integration was a key contributor to private sector innovation in the market economies of the 20th century. Far from being confined to embryonic inventions and fundamental research, universities contributed to applicationoriented sciences and engineering in many industrialized countries (Mazzoleni and Nelson, 2006; Rosenberg and Nelson, 1994). As production processes became increasingly sophisticated, trouble-shooting and incremental improvements came to rely increasingly on the fundamental knowledge held in universities.

The activities of universities and IRDIs increasingly tend to overlap. In the US, state university systems operate many of the Manufacturing Extension Partnership centers offering training and advice to industry. In Germany, the Steinbeis centers, part of a large network of centers offering technical assistance and industrial R&D services, are all associated with polytechnic institutions.

In Norway, SINTEF, an IRDI, involves Ph.D. students in many of its research projects.

Although universities and research institutes increasingly need to form tight intellectual partnerships to meet the needs of industry, their roles as service providers remain complementary.

IRDIs are easier and less risky to collaborate with as they are much more structured than universities and often make use of management processes and norms of confidentiality found in industry. IRDI staff is often more experienced and familiar with practical production processes than in universities and can also deliver directly applicable knowledge to industry. Most importantly, providing services to industry is the core business of an IRDI, whereas universities need to balance the tension between teaching and research (Arnold and others, 2006).

Universities, on the other hand, are not constrained by the stability and consistency of institutes which provides them with attributes that IRDIs do not have: (i) they are constantly regenerating their capabilities, with direct access to the next generation of scientists; and (ii) they are always under pressure to maintain a competitive edge to secure research grants. With this in mind, firms tend to rely on universities for human resources or for risky projects requiring strong problem-solving skills (Organization for Economic Co-operation and Development, 2004).

While, universities cannot compete with IRDIs to deliver short-term practical services to industry, the two must collaborate ever closely to support firms who need to keep up with a fastmoving technological frontier to compete on a global scale.

BAS has taken steps to bridge the gap between education and research in Bulgaria. An unintentional benefit of the low salaries at BAS is that many BAS researchers also teach at higher education institutions. This increases the exchange of scientific information between universities and BAS. BAS has also established a nationally accredited graduate school, which enables graduate students to be involved in its extensive research activities. Currently, 554 graduate students are enrolled at BAS, although this number has fallen significantly over the past five years, and BAS awards about 20 percent of Bulgaria’s PhDs. % of persons 20-29 in second-stage tertiary education in science and engineering

Figure 29: Bulgaria has a relatively low number of graduates in engineering and science 1.5

1.0

0.5

0.0

United Kingdom

Estonia

Source: Eurostat (2005).

Ireland

Romania Bulgaria Slovenia Croatia

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Bulgarian universities have limited ties with the productive sector. Seven universities have active Research and Development Sectors, independent units responsible for carrying out contract external funding from contract research. Although, external funding has increased in recent years most of these are from foreign sources, such as the EU’s Framework Program, and only a very limited share comes from the domestic productive sector. Although there is to date little evidence of their impact on technology commercialization, two universities have established technology transfer offices.

Technology Commercialization Infrastructure Bulgaria has developed limited numbers of the types of technology commercialization institutions typically found in OECD countries. These include technology transfer offices, entrepreneurship centers, technology parks and incubators. Most have been created in the non-profit sector, sometimes in coordination with universities and research institutes.

Technology transfer offices are being established in Bulgaria but their success may depend on improvements of IPR enforcement and they have yet to be subject to rigorous evaluations. The recently created GIS Transfer Center foundation is an example of good practice for technology transfer and has helped a number of research groups establish technology commercialization centers (see Box 5). Currently, eleven technology transfer centers are being established in various universities under the EU’s PHARE budget.

Two standard EU structures also operate in Bulgaria. The Innovation Relay Center (IRC) Bulgaria is part of the EU’s IRC Network and facilitates linkages between European and Bulgarian technology communities to promote technology transfer. It offers a number of technology-related business services to domestic firms willing to cooperate with other European firms. Several Euro Info Centers also operate in Bulgaria and provide information, consultancy and training to SMEs on topics related to FP7 and innovation. However, the impact of both of these structures on Bulgarian innovation is difficult to determine. Both have limited staff and resources, and the scope of their services is limited. An evaluation of the EU’s IRC Network found that its economic impact had yet to be demonstrated and that many technology transfer contracts did not deliver convincing results (European Commission, 2001).

Other activities to promote technology commercialization include Ministry of Economy and Energy programs to establish entrepreneurship centers at technical universities for training and assistance to business startups. Five pilot programs have been funded thus far. The success of all of these efforts may depend on Bulgaria’s ability to continue improving its IPR environment. The current situation of weak enforcement of IPRs may not provide the right incentives of technology commercialization through entrepreneurship or licensing.

Box 5: The GIS Transfer Center—an example of good practice in technology transfer The GIS Transfer Center (GIS-TC) Foundation—Sofia, one of the first structures established for commercializing technology in Bulgaria, was created in 2000 by the BAS and a number of other organizations as part of the German Steinbeis Transfer Center network. The purpose of the network is to establish technology transfer centers for specific technologies in partner institutions. So far, it has created 18 transfer centers, including 6 at the BAS. Sixty-five companies currently work with GIS-TC. The foundation provides assistance with grant funding or bank loan applications and conducts seminars and workshops for SMEs. GIS-TC does not receive any subsidies from the Bulgarian Government but derives its budget from services to SMEs and from managing several national and EU programs. GIS-TC operates with comparatively small annual budgets. Its annual turnover was of approximately 117,000 BGN (€57,000) in 2007 according to GIS-TC’ March 2008 Annual report.

Technology parks provide environments in which firms can rely on support infrastructure and services conducive to innovation and growth, unhindered by the market and coordination failures that typically affect knowledge-based organizations. Technology incubator programs focus on providing space and services to young start-ups with little business experience. A number of phenomena, from Silicon Valley in the United States to Cambridge in the UK, have inspired a number of countries to establish technology parks for the fast track development of their high-tech economy. However, it must be highlighted that the track record of technology parks and incubators as catalysts of technology commercialization in middle and low-income countries has yet to be established (Hackett and Dilts, 2004; Radosevic and Myrzakhmet, 2006; Siegel and others, 2003).

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There is currently only one technology park operating in Bulgaria, the Business Innovation Center IZOT (Box 6), and two recently established technology incubators in Varna and Gabrovo.

There are thirteen other business incubators established through a job creation program but they are not specific to technology-based sectors. So far, attempts by universities to build technology parks and incubators on their premises to help commercialize their research have been met legal obstacles concerning the prohibition of using university land for commercial purposes. Nonetheless, there are plans for important investments in technology parks in Bulgaria and several technology parks are in various phases of preparation. The creation of technology parks is one of the principal instruments to support innovation and entrepreneurship supported in Bulgaria’s National Regional Development Plan for the period 2000 – 2006, and the National Strategy for Regional Development for the period up to 2015.

The OP Competitiveness includes measures for establishing five to six technology parks in Bulgaria, along with technology incubators and technology transfer offices. The National Innovation Strategy also provides measures for supporting existing technoparks. In the long-term, technoparks and incubators could play an important role in facilitating technology commercialization in Bulgaria, but it is unclear that they can play a central role in this area in Bulgaria before other systemic issues are first reformed. These include the national funding structure for research, weak research culture in universities and unclear IPR ownership rules between research institutions, researchers and their clients. Furthermore, caution is warranted, as technology parks and incubators have had a mixed record in transition economies.

Box 6: The Business Innovation Center IZOT—a self-sustainable technology park The Business Innovation Center IZOT is the result of an employee buy-out of a privatized stateowned IRDI in 2000. IZOT now offers office, laboratory and manufacturing space, as well as services and equipment on a for-profit basis to its roughly 140 technology-based SMEs, most of which are headed by the former IRDI employees. Because of favorable terms of the employee buy-out, IZOT is able to offer discounted rents to its tenants, but does not receive any external subsidies. However, the IZOT model differs from that of most other technology parks found in OECD countries as it is not affiliated with any higher education or research institution and R&D is subsequently not an important component of its activities. Given the small size of IZOT’s client companies it is unlikely that it will be able to remain self-sustainable as a technology park in the near future. Already, the facilities and equipment it leases to its clients are becoming obsolete and are poorly maintained.

Technology Absorption and Innovation in SMEs In most countries, the competitiveness of SMEs is not hindered by their inability to license advanced technologies from abroad or patent their own technologies, but simply because most SMEs do not operate using principles of international best practice. These organizational and technological best practice principles can be costly to acquire in countries where SMEs operate in relative isolation from the relevant sources of knowledge. Many countries have come to realize that the gap between SMEs and the global technology frontier represents a tremendous opportunity for productivity gains. Most of the required knowledge, although costly to identify and assimilate, is available in the public domain unprotected by IPRs or secrecy.

Despite this, markets for consulting services for smaller firms seldom develop spontaneously.

Private consulting firms are reluctant to serve small firms because typical contracts are too small to justify their time and expenses and demand is poorly articulated (Oldsman, 1997). A number of countries have hence used public resources to help SMEs absorb mature (hard and soft) technologies and spur markets for SME consulting services. The Manufacturing Extension Partnership in the US and the Program of Comprehensive Quality and Modernization in Mexico are two such examples (see Box 7).

In Bulgaria, several programs have recently been initiated to support technology absorption in SMEs, but they operate in isolation from one another, and they either do not offer the comprehensive services and expertise required by SMEs. International experience shows that SMEs are often most receptive to programs that bundle business and technology services together. Other SME technology support programs in Bulgaria target only high-end innovation based on using IPRs as a market strategy.

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Box 7: The MEP and CIMO— two approaches to enhancing technology absorption in traditional manufacturing sectors In the United States, the Manufacturing Extension Partnership (MEP) aims at decreasing the productivity gap between small and large manufacturers, mostly in traditional sectors such as metal products, rubber and plastics. It finds its roots in economically depressed regions of the United States in the 1960’s. Although initially formalized at the federal government level to help SMEs modernize by adopting state-of-the-art manufacturing technologies, the MEP quickly realized that this type of assistance did not correspond to the needs of SMEs, a mistake often reproduced in low and middle income countries. Instead, the MEP provides support on “soft” methods such as statistical process control, just-in-time manufacturing, cell-focused manufacturing or greater attention to manufacturability in design, which can all lead to significant improvements in productivity without large capital expenditures (Shapira, 1996).

In Mexico, the Program of Comprehensive Quality and Modernization (CIMO),42 ran under that name from 1987 to 2001 to provide technical assistance and financial support for training and productivity enhancement to SMEs. CIMO’s strategy was to determine the individual weaknesses of firms through an initial diagnosis and provide consulting, training or technology appropriate to remedy those weaknesses. The program offered SMEs industrial information as well as scientific and technological knowledge. CIMO fostered linkages and scale economies by grouping firms and matching them with local consulting and training service providers.

VII. Policy Recommendations Create a more Effective Research, Technology and Innovation Policy Framework. Currently, several government entities develop and implement policy measures in an uncoordinated manner.

As outlined in the ABC Report, Bulgaria could consider developing an integrated national strategy for research and innovation policy under the guidance of a single consultative council that represents government, research and industry at a high political level. This would result in a more coherent national innovation system.

Leverage Public Financial Support for R&D and Innovation. There is a need to significantly increase national R&D expenditures to build the technology absorption capacities required to close the productivity gap with the rest of the EU. Investment in R&D is low in Bulgaria and has been in relative decline over the past decade. The role of the Government is not only to increase publiclyfunded R&D but also to stimulate R&D investments in the private sector, which still accounts for a very small share of total expenditures. Public sector R&D expenditures could be based on priorities set by a national research and innovation strategy that reflects Bulgaria’s state of economic and technological development. Funding could be allocated under the guidance of a single supraministerial commission on research, technology and innovation to ensure coherence in the funding of different institutions and funding programs.

Establish clear performance metrics and agreed strategic plans for public R&D funding.

Institutional or “discretionary” research funding to research institutes and universities needs to be based on agreed strategic plans in line with national research priorities and based on clear performance metrics. Multi-year funding commitments could be introduced to allow for research institutes and universities to be more strategic in their planning. Institutional funding may not only be conditional on prior performance but also on periodic independent evaluations of the recipient institutions.

As noted in the ABC Report, the share of funding that is provided on a competitive basis may need to be increased to reflect international best-practices. This will result in a more efficient national innovation system able to transform a greater share of R&D investments into applied results. The National Science Fund (NSF) is a good step in this direction and it is currently too small to have much of an impact on research effectiveness. At this time, given its limited budget and the absence of economies of scale for research in Bulgaria, NSF could consider focusing its resources on a selected number of thematic areas corresponding to Bulgaria’s national priorities (in accordance with the recommendations of the ABC Report). Concurrently, there is a need to increase grant sizes to reflect the lumpy and indivisible nature of research.

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Encourage R&D and Innovation in the Private Sector. The Government can stimulate R&D investments and innovation in the private sector through public financial support mechanisms, such as matching grants and loans. The National Innovation Fund (NIF) provides a growing and muchneeded source of funding for innovation in the productive sector. Moreover, the projected growth of the NIF’s budget over the next few years will have a positive impact on private sector innovation in Bulgaria.

It will be critical for Bulgaria to ensure that NIF has the capacity to increase the number of grants it awards. There have already been delays in application processing and reimbursements.

Any weaknesses in NIF need to be quickly identified and rectified. This may be achievable through periodic independent evaluations of NIF, following the NSF model. Some possible improvements of NIF include: -

increasing the share of match-funding provided to firms since the NIF’s co-funding requirements can be quite difficult for firms, particularly SMEs, to realize;

-

ensuring that competitions are fully transparent by making use of international committees for NIF proposal evaluations, as is done in NSF, and by announcing competitions early;

-

decreasing administrative costs for recipients of NIF funding by streamlining the application process and increasing grant sizes.

At present, NSF and NIF do not complement each other as much as they could because both offer grants for industry-research collaborative projects. Although efforts have been made to avoid duplication, this could be further avoided by having them each focus on distinct stages of R&D and technology commercialization. As a nexus between industry and research, NIF or NSF could also develop the capacity to support organizations wishing to apply for FP7 funding.

At this point, Bulgaria needs to focus on grants versus corporate income tax incentives, as these will require building significantly more coordination capacity between the various government agencies.

Close the Productivity Gap through Technology Absorption. The growth of NIF can be expected to bring much needed funding to private sector innovation in Bulgaria. In addition, Bulgaria could introduce schemes to facilitate technology absorption in firms. Most domestic firms in Bulgaria operate far from the technological frontier and would greatly benefit from adoption of existing technologies. Moreover, since innovation is most often the results of the improvements or combination of existing technologies, the effect of any measure for increasing innovation can be enhanced by measures to support technology absorption. Technology absorption schemes could be particularly helpful to SMEs and to firms in traditional manufacturing sectors, both of which are falling behind technologically. Such schemes could include: -

the creation of a network of technology extension centers focused on transferring productivity-enhancing hard and soft technologies to Bulgarian firms; this network should not be built from the ground up but should leverage technical resources from existing universities and research institutes in Bulgaria;

-

as part of the technology extension network, “soft” technology upgrading technical assistance and training programs focusing on quality and organizational processes that impact technology absorption, starting with simple productivity-enhancing methodologies to more involved lean production systems, and to quality systems;43

-

supplier development programs that help potential domestic suppliers to position themselves in global value chains in which they can benefit from knowledge and technology transfer from buyers;

-

a combination of matching grants and loans for technology-intensive manufacturing equipment for SMEs;

-

consultancy or training services to help domestic firms understand and negotiate technology licensing agreements, although this is likely to be of limited use to smaller firms.

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While FDI can also act as an important channel of technology diffusion, Bulgaria can ensure that it does not focus exclusively on corporate tax cuts or special tax concessions to attract this type of investment. These instruments alone are unlikely to attract FDI with high technological externalities.

Even with the knowledge-intensive FDI, spillovers will be minimal unless the technological absorptive capacities of local firms and of the local workforce are first enhanced. Providing domestic firms with support for technology absorption would make Bulgaria more attractive to knowledge-intensive FDI and maximize technological spillovers.

Increase Financing of Innovative Entrepreneurship. Although large mature Bulgarian firms have relatively good access to bank finance for innovation and technology absorption, pre-competitive research funding is limited and there is a significant gap in early stage technology commercialization (see Figure 30).

Availability of capital

Figure 30: There are limited sources of R&D finance and a severe early stage funding gap available to innovative startups in Bulgaria National National Science Fund & FP7

Bank loans Tax incentives Equity

National Innovation Fund Angels Venture capital

Basic research Development and set-upCommercial operations

Company growth Note: Conceptual representation not based on actual data.

The Government could facilitate the creation of seed and venture capital funds to bridge the gap between research and technology commercialization. In Bulgaria, there are few sources of finance available to close the gap between a firm’s R&D and expansion stages. While NSF, FP7 and NIF provide funding to firms, these can only be used to fund specific R&D projects, and not a firm’s start-up business activities. Seed funding could be initiated through the creation of a small public fund to invest in early-stage startups. Concurrently, the Government may encourage the creation of a business angel network. At a later stage, once these programs are in place and depending on a sufficient pipeline of projects, the Government could facilitate the creation of a privately-managed venture capital fund, through leveraged investments or other instruments that have been used successfully in countries such as Israel and Finland. The provision in the recent Bulgarian Development Bank Act for the establishment of a large venture capital fund to help SME’ development is a step in this direction but yet to be evaluated. Considerable care would need to be taken to ensure that the relevant management expertise is available before attempting to establish any such venture capital program.

Improve the Quantity and Quality of Human Resources for Innovation. The government could consider introducing measures to increase the scale and quality of its R&D workforce. These measures may target both the supply and demand sides of the labor market. On the supply side, investing in science and engineering education to strengthen Bulgaria’s technical workforce has to be a government priority. Bulgaria could also tap into its large scientific and engineering diaspora community by encouraging them to return. Brain circulation programs could support the placement of Bulgaria’s science and engineering diaspora in research institutes, universities and in private sector R&D projects. In this respect, the recent initiative by the National Science Fund with a program aiming at attracting back to the country native researchers seems to be a step in this direction. On the demand side, programs to subsidize internships for science and engineering graduates in R&D projects in industry can enhance firms’ understanding of the value of R&D and create a culture of innovation in the private sector.

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Establish an Environment for the Creation and Diffusion of Technology. Bulgaria could continue strengthening its IPR enforcement regime through capacity building and better coordination of enforcement agencies. If Bulgaria remains in the status quo, it runs the risk of discouraging domestic innovation and the transfer of technology by foreign investment firms.

Strengthen Linkages between Research Institutes, Universities and Industry. While on the demand side, scaling up financial support for industry-research collaboration can help increase linkages in the national innovation system, these measures are unlikely to be effective unless they are accompanied by measures that target the supply side of R&D to: a) reform research institutes and universities so that they are more market-driven; and b) establish bridging institutions. a) Reforming the supply of R&D Research institutes The Government may introduce more incentives for R&D institutes to increase their collaboration with industry, particularly in areas in which domestic firms are lagging behind their European counterparts. This will be a long and difficult process as there are no genuine industrial R&D institutes capable of effectively addressing the immediate technological needs of enterprises in Bulgaria. Rather than attempting to reform the entire BAS, which has an eclectic mix of basic and applied natural and social sciences ranging from philosophy to physics, the Government could reform selected BAS institutes which have the highest potential to be re-oriented toward industry.

Measures that can contribute to reshaping these institutes include the introduction of market departments, incentives schemes for researchers to seek contracts with industry, requirements for all self-initiated research projects to be formally vouched by industry, project management training for researchers, the introduction of researcher mobility schemes to increase their exposure to industrial problems and the introduction of industry representatives in the boards of directors of the individual institutes. These measures, together with a shift of focus from institutional to competitive funding, can help re-orient selected institutes operating under BAS towards the needs of domestic firms.

Universities If universities are to play any role in supporting private sector innovation through research, the Government may need to first significantly strengthen their research capabilities. Education and research are poorly integrated in Bulgaria, and universities tend to focus almost exclusively on their teaching roles. As mentioned earlier in this chapter, universities and research institutes play complementary roles in the national innovation system and a weak university research base cannot necessarily be compensated solely by strengthening research institutes. Research could be encouraged in Bulgarian universities by increasing the share of competitive funding reserved for universities until universities have developed their research capabilities. Finally, universities will have to aim to attract more science and engineering graduate students, which represent irreplaceable assets for certain types of industry research projects. b) Bridging institutions There are plans to establish a number of institutions to bridge the gap between research and industry, but Bulgaria could ensure that their sequencing is consistent with the level of development of the national innovation system. Bulgaria needs to ensure that other elements of its national innovation system are in place, such as proper funding mechanisms, IPR enforcement, marketdriven research institutes, before embarking on an ambitious and expensive program of technology commercialization infrastructure development. Technology parks and incubators carry high risks and have produced mixed results in many countries. A single pilot technology park could be established to develop a model that fits the Bulgarian context and builds domestic expertise in this area prior to developing any other technology parks. Similarly, Bulgaria may consider not scaling up its incubator program until existing incubators have been properly evaluated and fine-tuned to the needs of domestic firms. New incubation programs may focus on service provision rather than facilities to reduce market risk. As affiliating incubators and technology parks with universities present more opportunities for industry-research linkages, Bulgaria could change its legislation to allow universities to house incubators or technoparks on their premises.

Chapter 4: Standards and Quality I. Introduction Under the right conditions improving standards can accelerate technological progress, boost productivity and increase trade. Global buyers demand products and services that meet rigorous standards to ensure that they integrate flawlessly with other components of the supply chain, satisfy final customer requirements, and comply with a maze of technical regulations in importing countries. Yet, firms can only fully exploit the benefits of standards when a supportive national quality infrastructure is in place. The term national quality infrastructure denotes the infrastructure (public and private) to establish and implement standardization, metrology (scientific, industrial and legal), inspection, testing, certification (product and system) and accreditation services necessary to provide acceptable evidence that products and services meet defined requirements whether demanded by the authorities or the market (see Box 8).

Chapters 2 and 3 suggest that Bulgarian manufacturing firms are competing on price rather than on quality. While low labor costs allowed Bulgarian manufacturing firms to significantly increase their exports since the early transition period, domestic firms continue to compete in low valueadded activities which offer few opportunities for upgrading. By specializing in price-based market segments, Bulgarian firms run the risk of locking the country into a low-wage trap, forced to compete solely on price with new entrants from other low-cost countries. In contrast, competing on quality would give Bulgaria more sustainable growth and would provide the opportunity to upgrade to higher value-added activities in the long run. Experience shows that firms that are able to integrate into quality-based value chains are less vulnerable to unpredictable market demand and globally mobile capital. Producers of higher-quality goods benefit from tight relationships with global buyers, who play an active role in providing them with technical and organizational knowledge to comply with their standards. Having invested in their suppliers, high switching costs make buyers less likely to change partners to get lower prices in the short-term (Kaplinsky and Readman, 2001; Schmitz and Knorringa, 2000).

While access to quality-based market segments in the EU could present Bulgarian firms with a sustainable path to industrial upgrading, these are also the most difficult market segments to enter, as they depend on adhering to strict product, process and system standards. Bulgarian firms are faced with a particular challenge, as the country’s national quality infrastructure remains underdeveloped and not fully harmonized with those of its trading partners. As a result, Bulgarian firms remain trapped in low value-added activities and continue to face technical barriers when attempting to penetrate global markets.

II. Standards, Productivity and Growth Improving standards can increase firm-level productivity and innovation in several ways.

Standards lead to economies of scale and allow suppliers to achieve lower unit costs by producing large homogeneous batches of products. Standards spur and disseminate innovation by providing information on new technologies and methods. When information on innovation is codified in standards, it is diffused to the entire economy and gives firms a short-term competitive advantage in international markets. Standards also solve coordination failures. They facilitate the development of profitable networks by allowing participants to benefit from interacting with each other. Finally, standards enable the creation of high-quality markets. They communicate reliable and consistent information regarding the characteristics and quality of products and processes to consumers.

By allowing consumers to differentiate products of different quality, they reduce information asymmetries. By acting as a market signal for quality, standards improve the competitive advantage of firms that adopt them.

51

52

BULGARIA: Investment Climate Assessment

Firm-level studies have shown a positive relationship between quality, as embodied in standards, and productivity.44 Studies also show that standardization can lead to lower transaction costs in the economy as a whole and provide savings to individual businesses (Deutsches Institut fĂźr Normung e.V, 2000). At the macroeconomic level, several studies have found a significant positive long-run relationship between standards and economic growth. Time-series data for the UK showed that standards contributed about 13 percent of the growth in labor productivity in the UK from 1948 to 2002 (Department of Trade and Industry, 2008). A similar study for Germany found that standards contributed about 0.9 percentage points (out of an average growth rate of 3.3 percentage points) between 1960 and 1996 (Jungmittag and others, 1999).

Standards and the supporting quality infrastructure also play an important role in trade. Standards can either promote or impede trade depending on how they are established. On the positive side, standards can facilitate trade since they “stipulate what can or cannot be exchanged and define the procedures that must be followed for exchange to take place� (Brenton, 2004). As a result, complying with standards requirements in foreign markets is a critical factor in determining market access.

Conforming to shared standards is generally considered to promote trade (Blind and Jungmittag, 2005; Moenius, 2004; Swann and others, 1996).

But standards will not contribute to private sector development and trade if they cannot be easily accessed and adopted throughout an economy, if trade partners use too many different standards, or if they are poorly adapted to national needs. Standards will not exhibit many of the above benefits if they are not well documented, if they are difficult to find, if they are poorly understood, or if only a few companies are able to internalize their benefits or control their content.45 Moreover, if each country uses its own idiosyncratic or country-specific standards, global economies of scale will not be realized and firms may end up focusing exclusively on their domestic market. If products must be adapted to each market to conform to different national standards, adaptation costs can hinder trade.

III. The Bulgarian National Quality Infrastructure The conformity assessment process includes the activities used to evaluate whether a product, process or service fulfills specified technical requirements. These include the requirements described in voluntary and mandatory standards. The actual conformity assessment procedure differs according to the product or process, and can include any combination of testing, inspection, calibration and certification. Conformity assessment activities are supported by a multidimensional infrastructure of certification, inspection, testing, calibration, metrology, and accreditation and standardization organizations (Box 8).

Box 8: The Components of the national quality infrastructure Testing Laboratories and Inspection Bodies. Testing and inspection help demonstrate that a product or process satisfy certain technical requirements. Testing and inspection involve determining the characteristics or performance of a product or process according to a specified procedure. Independent testing laboratories and inspection bodies can be contracted by a firm to obtain a test or inspection certificate as evidence that a product or process conforms to certain characteristics. In certain cases, testing and inspection are required for firms to implement a quality control system, such as ISO 9001.

Certification Bodies. Third-party certification consists of the provision of assurance by an independent body (the certification body) that a product, service, system, process or material conforms to one or more standards or specifications. Manufacturers and service providers can have their products or their management systems certified to particular standards to distinguish themselves from less reputable suppliers. Certification by third-party organizations is required by some government regulations and is increasingly included in trade contracts. Certification bodies are usually commercial for-profit or non-profit entities, but in undeveloped markets they are sometimes public sector organizations.

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Calibration Laboratories. Calibration involves the determination of the relationship between an instrument’s input and the magnitude or response of its output. It serves to establish the accuracy and precision of a measuring instrument. Calibration laboratories can be internal, serving only the needs of the firm, or commercial. In the latter case, they serve industrial producers, testing laboratories, inspection bodies, research laboratories, universities and other final users. Many conformity assessment bodies require that equipment and measurement reference systems be calibrated or ‘traceable’ to widely-accepted metrological references provided by calibration laboratories, before they issue product or system certificate.

The National Standards Body. Standards provide the basis for evaluation of all conformity assessment bodies, and define the requirements against which conformity assessment is performed. National standards bodies are organizations that bring together public and private stakeholders to develop official national standards. Standards bodies usually adopt the standards through consensus and publish them to make them available to industry, public sector institutions and consumers. In most OECD and EU countries the national standards body is concerned with voluntary standards.

The National Accreditation Body. Accreditation is the procedure by which an authoritative body (the accreditation body) gives formal recognition that an organization or person is competent to carry out specific tasks. Conformity assessment bodies, such as certification bodies, inspection bodies and testing laboratories and calibration laboratories, can seek accreditation on a voluntary basis as a proof of competence in a given area. The accreditation body evaluates the personnel and supporting management system of the candidates for accreditation and can request practical tests for laboratories when relevant. Most countries have a single national accreditation body responsible for all areas of accreditation.

The National Metrology Institute. The role of a National Metrology Institute (NMI) is to establish the national measurement system, to maintain, develop and diffuse measurement standards for basic units and to diffuse metrological expertise to the economy. NMIs operate in the primary calibration market: they disseminate measurement standards by providing calibration services to independent calibration laboratories and to other organizations responsible for regulations and standards. When their industrial measurements are traceable to the NMI through an unbroken chain of comparisons, firms are able to guarantee the accuracy and precision of their calibration instruments, process control instruments and quality control instruments. Countries often have a single NMI, but when there are several NMIs each is responsible for distinct measurement areas.

Bulgaria has all of the necessary institutions for a complete national quality system. In the past five years, the national quality system has undergone significant restructuring, and the institutions involved in standardization, accreditation, market surveillance, certification, and scientific and legal metrology have been segregated into independent bodies: •

There are a number of certification and inspection bodies, as well as testing and calibration laboratories operating in both the private and public sectors. The government is involved in the market for voluntary certification and testing through the Executive Agency for Certification and Testing (EA CT). EA CT was created under the Ministry of Economy and Energy in 2002, as a transitional measure until a sufficient network of private conformity assessment bodies and laboratories is developed.

•

The Bulgarian Institute of Standardization (BIS) is the national standards body, responsible for the development of all national voluntary standards. It was established as a state structure in 2002, and became a non-governmental organization in 2006, operating according to the National Standardization Act of 2006. Ministries are responsible for the development of mandatory standards.

•

The Executive Agency Bulgarian Accreditation Service, (EA BAS), is the national accreditation body. EA BAS was established in 1999 through power of decree of the Council of Ministers as the national accreditation body. It is an Executive Agency at the Ministry of Economy and Energy. EA BAS is responsible for accrediting certification bodies, inspection bodies and laboratories according to national and international standards. It functions according to the 2005 Law on Accreditation, amended in 2006.

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BULGARIA: Investment Climate Assessment

•

The Bulgarian Institute of Metrology (BIM) is the National Metrology Institute, responsible for scientific metrology as well as some areas of legal metrology. BIM is a state body under the Council of Minister which was segregated from the State Agency for Metrology and Technical Surveillance (SAMTS) in 2006. BIM performs the typical functions of a national scientific metrology institute by maintaining national measurement standards, offering calibration services, and performing metrology R&D. BIM also performs several legal metrology functions, such as type approval, registration and initial verification of measuring instruments. It represents Bulgaria at the international level for both scientific and legal metrology. The responsibilities of BIM are provided in the Law on Measurements, adopted in 2002 and amended in 2005.

•

The State Agency for Metrology and Technical Surveillance (SAMTS) is responsible for the enforcement of legal metrology, the enforcement of most New Approach directives and the inspection of high-risk equipment. The metrological responsibilities of SAMTS are provided in the Law on Measurements. The Law on Technical Requirements for Products, last amended in May 2005, tasks SAMTS with the market surveillance of products under the New Approach directives and the designation of Notified Bodies46 for most New Approach directives, the remaining directives being under the responsibilities of other relevant government bodies (see Box 9). SAMTS is under the responsibility of the Council of Ministers and functionally associated to the Minister of Economy and Energy.

•

The Directorate of EU Integration at the Ministry of Economy and Energy is responsible for coordinating the national quality infrastructure within the Framework of free movement of goods. It coordinates the harmonization of Bulgarian legislation with EU directives, prepares the budget for the various quality infrastructure institutions and participates in the advisory councils of SAMTS, EA BAS and BIM. The Directorate also participates in the drafting of standards in BDS technical committees.

Box 9: Conformity assessment and access to the EU market Quality infrastructure plays an important role in European integration. In order to participate in the EU free market and implement the acquis communautaire, a country needs a conformity assessment infrastructure adapted to harmonized EU legislation.

The Old Approach and the New Approach are the two strategies used for technical harmonization in the EU. Member states are obliged to transpose the Directives related to the Old and New Approach into their legislation. The Old Approach Directives contain detailed technical specifications for individual products. Under the New Approach, legislative harmonization is limited to essential requirements, which are stated in general terms, and mostly concern the areas of safety, public health, consumer protection and environmental protection. The development of technical specifications necessary for the implementation of New Approach Directives is requested from the different European standards bodies (CEN, CENELEC and ETSI). These ‘harmonized standards’ retain their status as voluntary European Standards but national authorities are obliged to recognize products manufactured according to these standards as conforming to the essential legal requirements of the directives. Since 1985, the New Approach has been the harmonization method used for most industrial products.

The Global Approach to certification and testing establishes European Community policy on conformity assessment. The CE marking on a product symbolizes conformity to all the obligations required by the applicable New Approach directives. In Bulgaria, most products that are covered by New Approach Directives can be CE marked through self-declaration of the manufacturer. However, for some products, third party conformity assessment and delivery of the CE marking must be conducted by ‘Notified Bodies’. These bodies must be nominated by member states and accepted by the EU Commission.

Chapter 4: Standards and Quality

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IV. Conformity Assessment Adoption of Quality Standards in Bulgarian Firms Not only does the adoption of quality standards facilitate technology adoption and enhance the efficiency of innovation but improving quality can be an important driver of innovation. According to the EU’s Community Innovation Survey, improved product and service quality is the most important driver of innovation in Bulgarian firms, and to a larger extent than in other countries (Figure 31). This suggests a mutual-reinforcing relationship between innovation and quality adoption in Bulgaria.

Figure 31: Highly important effects of innovation during 2002-2004 in enterprises with innovative activities Bulgaria

Improved quality in goods or services

Mean

60%

Reduced materials and energy per unit output

40%

Increased range of goods and services

20%

Reduced environmental impacts or improved health and safety

0%

Reduced labour costs per unit output Met regulation requirements

Entered new markets or increasedmarket share

Improved flexibility of production or service provision Increased capacity of production or service provision

Source: Eurostat Community Innovation Survey 4. Mean includes EU-27 + Norway + Iceland.

ISO 9001 certification can help diffuse quality in the productive sector and decrease transaction costs in international trade by decreasing information asymmetries between domestic producers and foreign buyers. ISO certification has been growing quickly in Bulgaria. In December 2006, there were 3,097 ISO 9001 certificates in Bulgaria. This is a 40 percent increase from 2005. In 2000, Bulgaria accounted for 0.06 percent of global ISO 9000 certificates. This share had increased to 0.34 percent in 2006 (Figure 32). While Bulgaria has been catching-up with high-income countries, it has done so more rapidly many other EU accession countries.47 If ISO certification continues to increase at this rate, Bulgaria will be well-positioned to compete on quality against other neighboring countries with low labor costs.

Certificates in Bulgaria

3500

# of ISO 9000 certificates

3000

% of world total of ISO 9000 certificates

2500

% of EU total for ISO 9000 certificates

2000

% of EU accession country total for ISO 9000 certificates

1500

5 4 3 2

1000

1

500 0

6

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Bulgaria's share of certificates

Figure 32: Certification rates are increasing rapidly in Bulgaria

0

Source: ISO (2001) The ISO Survey of ISO 9000 and ISO 14000 Certificates – Tenth cycle; ISO (2003) The ISO Survey of ISO 9001:2000 and ISO 14001 Certificates; ISO (2006) The ISO Survey of Certifications 2005.

Note: All data are for Bulgaria. Data before 2004 is for ISO 9000, data from 2004 onward is for ISO 9001.

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BULGARIA: Investment Climate Assessment

Further, Bulgaria has adopted more ISO 9001 standards in the manufacturing sector than would be predicted by EU averages based upon the number of firms in Bulgaria. Slightly more than 4 percent of manufacturing establishments are certified to ISO 9001 in Bulgaria, ranking the country it in the top half of EU member economies. Bulgaria also performs above its predicted level of ISO 9001 adoption based on EU averages (see Figure 33). In manufacturing, certification is mostly fueled by exports to the EU, where ISO 9001 is often a buyer or regulatory requirement.

number of ISO 9001 certificates (log)

Figure 33: Bulgaria has more certifications than other EU countries when accounting for the number of enterprises 12 20%

11

10% Germany

10

United Kingdom

9 Netherlands

8

Belgium

7 6 5 4

Bulgaria

Ireland Cyprus Estonia

Slovakia

Slovenia

Lithuania

Austria Finland

Hungary Romania

5% 2%

France

1%

CzechRep

Portugal

Sweden

Spain

Poland

Greece

Denmark

Latvia

8

9

10

11

12

13

number of enterprises (log) isoquant of the number of certificates per enterprise predicted certification rate Source: ISO (2006). The ISO Survey of Certifications 2004; Eurostat (2007).

Note: Data does not include Italy, Luxemburg and Malta; 2002 enterprise data is used for Belgium and Portugal.

While certification rates are reasonably high in Bulgaria as a whole, small firms lag far behind medium and large firms. Certification to international standards involves a long a costly preparation process which often requires training, consulting services and sometimes additional testing and calibration of equipment. Overcoming these obstacles can be particularly challenging for small firms, due to size constraints, which make it impossible to assign a dedicated staff member to the certification process, and to limited access to finance. Small firms also often lack the relevant information to perform a cost-benefit analysis of certification.

In Bulgaria, small firms are much less likely to have an ISO certification than medium or large firms. Only 16 percent of small firms responded that they had an ISO certification in the Enterprise Survey compared to 38 percent of medium firms (see Table 17). This is true even when considering only exporters, even though certification is often needed to enter quality-based market segments.

Table 17: In Bulgaria, certification rates are much lower for small firms Share of Bulgarian firms with an ISO certification: - all firms - significant exporters*

Source: World Bank Enterprise Survey (2007). * Firms with > 50 percent of their revenues from direct exports.

Small

Medium

Large

16% 26%

38% 52%

52% 77%

Voluntary standards The voluntary conformity assessment market is dynamic and competitive, with a government structure holding a small share of the market. The supply of conformity assessment services is growing, and there are now more than 20 active quality management system certification bodies and more than 130 testing laboratories in Bulgaria (see Figure 34). Most of the leading certification bodies are subsidiaries of multinational firms based in Europe, such as BVQI, SGS, LRQA, TUV and Moody’s.

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Figure 34: The quality management system certification market is competitive in Bulgaria Moody 9%

Others 24%

TUV 9%

LRQA 14% SGS 24%

Bureau Veritas 20%

Source: Certification bodies operating in Bulgaria.

Note: Market shares are as of July 2007.

The Government provides testing and certification services to industry through the Executive Agency for Certification and Testing (EA CT) which holds approximately 4 percent of the market for ISO 9001 certification. In 2002, EA CT was separated from the national standards body, and created as a transitional structure that would be transformed and registered into Commercial Law after two years. It was expected that a sufficient network of private conformity assessment bodies and laboratories would be developed during EA CT’s transitional period as a state-owned agency.

However, although the private sector market for certification and testing is now dynamic, EA CT remains state-owned.

Electro-magnetic compatibility (EMC) testing is the primary service that EA CT provides which is not available elsewhere in Bulgaria. In many countries, the national metrology institute is responsible for this type of facility. In Bulgaria, the Bulgarian Institute of Metrology (BIM) does not have its own EMC laboratory but makes use of EA CT’s as the national EMC laboratory. It is not clear that it is efficient to have this laboratory housed under a government agency separate from BIM. Moreover, this may pose conflicts of interests. EA CT operates under the same Ministry as the national accreditation body, EA BAS, which provides it with accreditation. Furthermore, the State Agency for Metrological and Technical Surveillance, SAMTS, which has designated EA CT as a Notified Body, has a functional relationship with that same Ministry.

Bulgaria has a lot of quality management system auditors and consultants with internationally recognized credentials. Bulgaria has more International Register of Certificated Auditors (IRCA) -certified lead auditors than countries such as Malaysia, Spain or Poland do (see Figure 35).48 This suggests that qualified auditors do not limit the diffusion of quality among Bulgarian firms.

Conformance to EU Directives Figure 35: Bulgaria has a lot of internationally-recognized ISO 9001 auditors Number of IRCA lead auditors per million people

20 18 16 14 12 10

8 6 4 2

Source: IRCA website, www.irca.org, May 2007; World Bank WDI & GDF. Note: IRCA data is May. 2007; Population data is for 2005.

Chile

Mexico

Turkey

Poland

Romania

Hungary

Spain

Malaysia

Bulgaria

South Korea

United Kingdom

0

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BULGARIA: Investment Climate Assessment

Bulgaria’s has designated a number of Notified Bodies for the certification of products subject to the New Approach EU directives, but they do not cover some important directives. In Bulgaria, the State Agency for Metrology and Technical Surveillance (SAMTS) is responsible for determining the procedures for, and approve, Notified Bodies for 23 out of 27 New Approach directives. The remaining four Directives are the responsibility of the Executive Agency for Maritime Administration, the Ministry of Regional Development and Public Works, and the Railway Administration Executive Agency. There are currently 26 Notified Bodies designated for 15 directives in Bulgaria, a relatively high number of bodies for a country the size of Bulgaria (see Figure 36).

Figure 36: Number of national Notified Bodies in selected countries as of June 2007 16

300

14

250

12

200

10 8

150

6

100

4

50

2 0

0 United Kingdom

Spain

Number of Notified Bodies

Poland

Romania

Bulgaria

Hungary

Turkey

Number per US$10bn manufacturing and services value added

Source: Nando Information System, http://europa.eu.int/comm/enterprise/nando-is, as of April 2, 2008; World Bank WDI database. Note: Manufacturing value added and services data is for 2005, except Spain and Hungary, 2004.

Notified Bodies have not been designated for several directives which are important to the Bulgarian economy. These include the directive on personal protective equipment, the directive on hot-water boilers and the directive on cableway installations designed to carry persons. In the absence of domestic Notified Bodies, Bulgarian firms need to rely on the services of organizations notified in other European countries to obtain their CE markings, which could result in higher logistic costs and therefore negatively affect their productivity. The designation of local Notified Bodies for directives relevant to the Bulgarian economy would make them more accessible to domestic firms, decrease the costs of notification, and allow more firms to produce goods compliant with European directives.

Quality Promotion Policies and Programs There are several public and private initiatives to promote the adoption of quality and standards in Bulgarian firms, although these programs have yet to be evaluated. The government offers consulting services on quality improvement through the Bulgarian Small and Medium Enterprise Promotion Agency (BSMEPA). Some ministries also promote certification through procurement requirements, although this is not widespread.

Business associations are also active in this area. Club 9000 organizes seminars, conferences and training for managers and their firms in the area of quality management systems. The Bulgarian Chamber of Commerce and Industry also provides consulting services in the area of quality systems.

Several programs are funded by external aid. With the support of the European Commission, the Bulgarian Euro Info Centre Network provides advice and consultancy on standards issues concerning the European market, such as product certification, application of European environmental standards and CE marking. An important initiative is the Business Advisory Services Program, a multi-donor program assisting SMEs, managed by the European Bank of Reconstruction and Development. The program co-finances business consulting services to implement quality management systems.

EU Structural Funds should support new measures for the diffusion of standards and quality practices. The Operational Program “Development of the Competitiveness of the Bulgarian Economy� approved by the EC in September 2007 includes a program to help firms comply with internationallyrecognized standards. The program will cover consultations and training services connected with the introduction of management systems, purchase of equipment and improvement of infrastructure of

Chapter 4: Standards and Quality

59

the production facilities related to the introduction or certification against international standards.

The program will be evaluated according to the number of certificates introduced in enterprises.

Although ISO 9001 certification provides a signal that a firm adheres to a recognized management system there is only mixed evidence that it actually improves quality and organizational performance (Guasch and others, 2007). Many companies pursue certification to satisfy customer requirements but revert to traditional practices after certification, nullifying certification’s benefits (Terziovski and others, 1997). Certification should therefore be regarded as necessary rather than sufficient for quality improvements. It is therefore important to remember that certification is a first step to further quality upgrading and not an end in itself.

Policy Recommendations Change the Executive Agency for Testing and Certification (EA CT) from a public to a private organization. The market for certification and testing is now mature and does not require the provision of conformity assessment services by the state. Government involvement could distort the market. Further, EA CT is under the same ministry as the organization that accredits it, creating a potential conflict of interest. If EA CT is privatized, it is might not be able to maintain its electromagnetic compatibility (EMC) testing facilities without government subsidies. Care must therefore be taken to ensure that EMC testing remains available. If needed, the Government could consider transferring EA CT’s EMC laboratory to the Bulgarian Institute of Metrology (BIM).

Provide training and consultancy services for Notified Bodies. Notified bodies are essential to the adherence of EU directive in Bulgaria and in export markets in the EU. Notified Bodies have not been designated for many EU New Approach directives in Bulgaria but are missing in some key areas. Becoming a notified body requires technical capacity and investments that may be lacking in some areas. The government could ensure that all relevant EU directives are covered by Notified Bodies by providing training and consultancy services to conformity assessment organizations aspiring to become Notified Bodies.

Supply programs to support quality upgrading in firms should continue beyond certification.

International certification has little or no effect on firm performance if it is simply adopted superficially to meet customer requirements. Support for quality management system certification may be integrated as part of wider schemes that are evaluated against actual quality improvement in firms, not just the firm’s ability to meet the requirement of the standard.

Support firm innovation and quality adoption in parallel. While innovation leads to quality improvements, adopting quality standards can help integrate firms in market segments in which there is more demand for innovation. Policies to support innovation and quality reinforce each other and should be complementary. The government could consider promoting programs for firms where support for adoption of quality practices is coupled with support for innovation.

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BULGARIA: Investment Climate Assessment

V. Accreditation Accreditation Activities in Bulgaria While Bulgaria has accredited many inspection bodies and testing laboratories, accreditation activities is limited in some important areas.49 As of June 2007, 412 organizations had been accredited and there were 136 applications under process. Most of these are small inspection bodies and testing laboratories, often accredited for a narrow scope of inspection or testing. In fact, Bulgaria has accredited more inspection bodies than in the comparator countries (see Figure 37). The same does not hold with regards to the accreditation of quality and environmental management system certification bodies, two key areas for enhancing productivity and exports. Bulgaria has accredited far fewer certification bodies than Hungary, a similar-sized new entrant to the EU. Figure 37: Bulgaria has accredited a high number of testing and inspection bodies, but very few system certification laboratories

Personnel cert. bodies

Inspection bodies

Product cert. bodies Testing lab.

Environ. system cert. bodies

Calibration lab.

Quality system cert. bodies 0

10 20 30 # of accredited bodies Bulgaria

Hungary

0 Romania

100 200 300 # of accredited bodies

Malaysia

Source: World Bank survey of accreditation bodies.

Note: Data shown if for June 2007.

The number of accredited bodies has increased significantly over the past decade. While there were 14 bodies accredited by EA BAS in 2000 and only 168 in 2003, this had more than doubled to 412 by 2007 (see Table 18). However, most of this increase is due to the growth of the inspection body and testing laboratory market, and to a minor extent, calibration laboratories. Other areas of accreditation have stagnated or receded.

Table 18: Number of EA BAS-accredited bodies each year  Testing laboratories Calibration laboratories Quality system certification bodies Environmental system certification bodies Product certification bodies Personnel certification bodies Inspection bodies EMAS verifiers TOTAL

2000 0 0 0 0 1 0 13 0 14

Source: EA BAS; Danish Technological Institute (2003, 2006).

2003 47 4 3 0 4 2 108 0 168

2006 136 25 2 1 9 2 163 0 338

2007 156 29 2 1 9 3 212 0 412

Bulgaria is relatively slow at delivering accreditations. The internal regulations of accreditation bodies often stipulate a maximum allowable time for this. In Bulgaria, not only is the maximum time imposed in the Law on Accreditation (18 months) far greater than in any other countries (see Table

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Chapter 4: Standards and Quality

19), but actual accreditation times sometimes exceeds the legal limit. In practice, the minimum time to obtain an accreditation is more than 10 months, which is longer than the maximum allowable time in many countries. As a result, there are currently far more applications under process than EA BAS can process each year. The slow accreditation process reduces demand for domestic accreditation and slows down the diffusion of quality among firms.

Table 19: The accreditation process is slow in Bulgaria

Maximum time to accredit a certification body (months)

Bulgaria

Turkey

Hungary

Poland

S. Korea

Spain

18

6

6

6

5

5

Source: World Bank survey of accreditation bodies (2007).

Demand for EA BAS accreditation is low, leading to quality problems in the market for certification. Of the more than 20 system certification bodies in Bulgaria, only two are accredited by EA BAS. One of these is EA CT, which is under the same Ministry as EA BAS. This is because EA BAS accreditation is not highly valued and that certification bodies operating in Bulgaria, most of which are subsidiaries of foreign entities, prefer to seek accreditation from foreign signatories of the European co-operation for Accreditation Multilateral Agreement (EA-MLA). Accreditation by an EA-MLA body is recognized both in Bulgaria and abroad.

However, local stakeholders question the ethics of some foreign-accredited bodies active in the Bulgarian market. They claim that these bodies perform poor audits and grant certificates quickly and cheaply.50 Cross-frontier accreditation can lead to problems because it often entails less rigorous surveillance.51 A more prevalent role of EA BAS in accrediting domestic certification bodies would support better business ethics and ensure that certified Bulgarian firms are genuinely adopting quality management system practices.

Participation in a proficiency testing program enables a laboratory or inspection body to objectively demonstrate its technical competence and is an essential component of the accreditation process. Proficiency testing programs are typically offered by different types of organizations, including national or regional accreditation bodies, governments and commercial providers. The European Co-operation for Accreditation recommends that accredited laboratories participate in at least one proficiency testing activity before accreditation, and in one activity before the end of the accreditation’s validity. EA BAS requires that accredited laboratories participate in proficiency testing programs in fields in which such programs are relevant. To date, few such programs have been organized by EA BAS and there are not enough programs to satisfy the needs of accredited laboratories in Bulgaria.

Institutional Structure of Accreditation in Bulgaria Both accreditatio n and certification can be found under the Ministry of Economy and Energy in Bulgaria. In 1999, the government divided the Committee for Standardization and Metrology into various institutions responsible for different components of the national quality system. However, the national accreditation body, EA BAS, and the public testing and certification body, EA CT, are under the same Ministry. Although EA BAS has signed a declaration of independence with the Ministry, it is unclear whether the agencies are shielded from conflicts of interest.

Private sector accreditation stakeholders have limited influence in the governance of the national accreditation odies can be operated by the public or private sectors (see Table 20), the private sector is typically involved in the governance of that national accreditation body. In Bulgaria, according to the Law on Accreditation both the public and private sectors are represented in an Accreditation Council,52 but this body is granted a largely advisory role.53 Moreover, most of the executive power rests with an Executive Director appointed by the government. In contrast, in countries such as Spain, the United Kingdom, Turkey, Hungary and Romania, the accreditation body has a general assembly of private and public sector members who have a voice in the governance of the institution. Further, the Executive Director plays a role in the appointment of accreditation personnel and technical experts in Bulgaria. In other countries, the selection of the workforce is not the responsibility of political appointees.

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BULGARIA: Investment Climate Assessment

Table 20: In Bulgaria, the national accreditation body has limited private sector representation % of executive Legal General Consultative Executive director council members status assembly council appointed by appointed by government government

Bulgaria

Chile Hungary Mexico Poland Spain Turkey UK

Public

No

Yes

Private Public Private Public Private Public Private

No Yes Yes Yes Yes Yes Yes

No Yes No Yes Yes Yes Yes

No executive council 100 33 28 100 0 71 0

Yes No No No Yes Yes Yes No

The Decree for the Structural Regulations of EA BAS54 is constraining and gives the institution little administrative autonomy. It prescribes the number of personnel, their distribution in different administrative departments, and the description of titles. It also prescribes an administrative structure and accreditation procedure in a level of detail that does not allow EA BAS to improve the efficiency of its operations. The institution’s budget must be approved by the government, although the government contributes little in net terms.

While the Bulgarian Accreditation Service (EA BAS) accredits conformity assessment bodies, SAMTS designates Notified Bodies and carries out the surveillance of these bodies. The existence of two parallel systems of quality assurance of conformity assessment bodies in Bulgaria creates inefficiencies. Although accreditation is not a requirement for becoming a Notified Body in Bulgaria, some of the Notified Bodies are accredited. Both systems require the same types of processes, personnel and administration. The presence of two independent systems can impose heavy burdens on firms that need to be audited by two different bodies.

Resources for Accreditation As a state agency, EA BAS obtains its financing from and transferred its revenues to the state budget. In 2005, EA BAS’ budget was BGN 546 207 (US$ 350 000), comparable to other countries when accounting for Bulgaria’s economic size (See Figure 38). The agency’s budget more than doubled from 2002 and 2005, and its revenues have roughly equaled expenditures during that time period.

Figure 38: Bulgaria dedicates comparable resources than other countries when accounting for income level and the amount has been steadily increasing 2006

Bulgaria

2005

Hungary

2004

Chile

2003

Turkey

2002

Poland

$0 0

10

20

30

Accreditation body budget (% of GDP)

$200,000 $400,000 $600,000 Revenues

Expenditures

Accreditation body budget ('000 US$)

Source: World Bank survey of accreditation bodies.

Note: 2006 data used for Bulgaria, 2002 for Chile, 2005 for all others.

EA BAS was financially sustainable for most of 2002 through 2006. Since 2002, most of the institution’s revenues have been raised through accreditation fees and, to a minor extent, by sale of publications, training courses and seminars. Its profitability demonstrates that demand for

Chapter 4: Standards and Quality

63

accreditation is high in some sectors, and that EA BAS could expand its administrative and technical capacity, particularly in the area of accreditation of certification bodies, where the national market for accreditation is still weak.

EA BAS has adequate staff considering the number of accredited entities. But this does not allow it to process the high volume of incoming applications. EA BAS employs 22 full-time officers, which is within the norm in terms of the annual number of accreditation delivered by the institution (see Figure 39). However, EA BAS suffers from high staff turnover, in part due to low salaries subject to public sector regulations. High staff turnover, combined with an insufficient number of administrative staff, may be limiting the agency’s capacity to process applications. As a result, there is a sizeable backlog of accreditation applications. To remedy this, the Ministry of Economy and Energy’s Directorate of EU Integration has recently introduced a measure to add 12 additional staff to EA BAS. The Decree on Structural Regulations of EA BAS does not allow the hiring of additional staff without the approval of new legislation. The agency’s limited autonomy hampers its flexibility and ability to respond effectively to changing market demand. This could constrain the growth of accreditation.

Figure 39: The Bulgaria national accreditation body has an adequate number of staff to handle the current volume of accredited entities Chile

Chile

Bulgaria

Bulgaria

Turkey

Turkey

Poland

Poland

Spain

Spain

Mexico

Mexico

United Kingdom

United Kingdom 0

50

100

150

0

10

20

30

40

50

Number of Permanant Staff Cases per permanant staff Source: World Bank survey of accreditation bodies.

Note: 2007 data used for Bulgaria and the United Kingdom; 2006 data for all other countries.

EA BAS has access to an abundant pool of qualified technical personnel—60 qualified assessors and 27 qualified technical experts. The number of lead assessors in Bulgaria is higher than in many other countries after taking size into account (see Figure 40). In Bulgaria, as is customary in accreditation bodies, most assessors are not part of the permanent staff but work on short-term contracts. A large pool of assessors implies ample additional technical capacity to accredit Bulgarian laboratories and certification bodies.

Figure 40: Bulgaria has access to a relatively large pool of accreditation assessors Turkey

Turkey

Chile

Chile

Bulgaria

Bulgaria

Poland

Poland

Hungary

Hungary

Mexico

Mexico

0

50

100

150

Number of lead assessors

0

10

20

30

40

50

Lead assessors per US$10 billion manufacturing and service VA

Source: World Bank survey of accreditation bodies.

Note: 2007 data for Bulgaria; 2006 data for Hungary, Poland and Turkey; 2005 data for all other countries.

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BULGARIA: Investment Climate Assessment

Regional and International Integration and Recognition Bulgarian accreditations do not benefit from a high degree of international recognition (see Table 21). In 2005, Bulgaria was admitted to the European Co-operation for Accreditation (EA)55 Multi Lateral Agreement (MLA) in two areas: quality systems certification and personnel certification. This enabled EA BAS’ accreditation to be recognized within and beyond the EU/EFTA region. Bulgaria has applied for the EA-MLA in the four other areas of accreditation.56 Bulgaria’s membership was suspended in March 2007 because the Accreditation Council was not operational and there was no procedure to appeal against an accreditation decision. The agency was re-evaluated by EA and readmitted in September 2007.

However, Bulgaria’s accreditation system is less well integrated than any of the comparator countries shown (see Table 21). While Bulgaria is not a member of either of the two main international accreditation organizations, ILAC and IAF, Romania, which joined the EU at the same time, is a member of both, has signed the ILAC-MRA and has signed the EA-MLA in six out of seven areas. While Turkey is only an EU candidate country, it has signed the EA-MLA in three areas and its accreditation system is thus more integrated with the EU than Bulgaria’s. As a result of Bulgaria’s adhesion to only two out of seven areas of the EA-MLA, and its subsequent suspension from the EA-MLA, firms with certification or test results from domestically accredited organizations faced constraints in selling their goods and services abroad or to foreign subsidiaries.

This situation has partly improved since Bulgaria’s readmission to two areas of the MLA. However, certification bodies and laboratories in the five remaining EA-MLA areas not covered in Bulgaria are less likely to seek accreditation from EA BAS due to its lack of international recognition. This hampers the development of the conformity assessment market in Bulgaria, and negatively affects the rate of adoption of quality-related practices in firms.

Table 21: The Bulgarian accreditation lags behind in terms of international integration Organizations MLAs/MRAs EA-MLA

IAF ILAC EA IAF –MLA ILAC-MRA (# of areas) Bulgaria No No Yes No No 2 Chile Yes Assoc NA No No NA Hungary No Assoc Yes No No 0 Korea Yes Yes NA Yes Yes NA Malaysia Yes Yes NA Yes Yes NA Mexico Yes Yes NA Yes Yes NA Poland Yes Yes Yes Yes Yes 7 Romania Yes Yes Yes No Yes 6 Spain Yes Yes Yes Yes Yes 7 Turkey Yes Yes Yes No Yes 3 UK Yes Yes Yes Yes Yes 7

Source: IAF, ILAC and EA websites.

Note: NA = not applicable; Assoc. = associate member; EA-MLA areas include calibration, testing, product certification, quality management system certification, environmental management system certification, personnel certification and inspection. Data is as of April 1, 2008.

Policy Recommendations Consolidate the accreditation system with the Notified Body designation system. Two independent quality assurance systems for conformity assessment bodies exist in Bulgaria, creating redundancies. There are opportunities for rationalization, and Bulgaria could consider giving some of the notification tasks to the Bulgarian Accreditation Service (EA BAS). The European Commission officially recognizes accreditation as a means of selecting Notified Bodies and this procedure has been used in several European countries. It would be important to strengthen EA BAS in parallel to ensure efficiency in the notification process in Bulgaria.

Privatize the Executive Agency for Bulgarian Accreditation Service (EA BAS) if there is inability to provide it with more private sector representation and autonomy under its current legal status. Currently, the private sector is not represented on the board of directors or in the general assembly and the private sector’s role in the Accreditation Council is limited. EA BAS serves mainly the private sector and should include industry representation, including associations of conformity assessment bodies such as BULLAB. Moreover, legislation on EA BAS’s structural

Chapter 4: Standards and Quality

65

regulations could be less prescriptive and could provide the organization with more autonomy.

Because national legislation prescribes EA BAS’ administrative structure, accreditation processes, salaries and workforce, this makes it difficult for EA BAS to adapt itself to changing market requirements and result in inefficiencies. Administrative structure, accreditation processes and workforce issues could be addressed by the institution’s internal regulations instead. The government could consider privatizing EA BAS if legislation cannot otherwise accommodate an increase in stakeholder representation and autonomy.

Select EA BAS technical personnel with the oversight of a technical council rather than make selection a discretionary responsibility of a public sector nominee. The Executive Director is nominated by the government and could appoint staff for political motives. It might be preferable for a technical council to oversee the selection process or for other management personnel to be responsible for selecting the workforce.

Accreditation delivery times could be shortened to make accreditation more appealing to the private sector. Internal regulations could significantly shorten the maximum allowable accreditation time to make EA BAS competitive with foreign accreditation bodies and not place Bulgarian certification bodies and laboratories at a disadvantage compared to their foreign competitors when they are applying for accreditation. Increased staff salaries and flexibility in the structure of the workforce would also shorten the accreditation process.

EA BAS is still faced with an underdeveloped market for certification body accreditation and could invest in this area with the help of the Government. The development of the market for accreditation of certification bodies will require investment from both the supply and demand sides.

On the supply side, reinvesting profits from EA BAS’ operations would help develop its market for accreditation of certification bodies. On the demand side, the government could consider funding programs that support accreditation of certification bodies through technical training and matching grants.

Support proficiency testing programs. Proficiency testing programs are expensive and require significant technical expertise. However, proficiency testing is required for many types of laboratory accreditation. Providing support for proficiency testing programs would increase the quality of the services of the accredited laboratories in the Bulgarian market, and thereby increase quality of their private sector clients.

Seek full membership in the IAF and ILAC. Most EA members are also full members of the IAF and ILAC. This allows them to gain greater international recognition and to become involved in technical cooperation with countries outside of Europe.

Become a signatory to all areas of the multilateral agreement for European cooperation for accreditation (EA-MLA). Bulgarian testing and calibration laboratories as well as inspection bodies accredited by EA BAS cannot be recognized abroad. EA BAS should take all necessary steps to secure membership in the remaining five areas of the EA-MLA.

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BULGARIA: Investment Climate Assessment

VI. Metrology Activities of the Bulgarian National Metrology Institute Compared to other EU accession countries, the National Metrology Institute, BIM, provides few calibration services and of these only a small share are to commercial calibration laboratories.

For example, BIM provided a tenth of the calibration services of the national metrology institute in Hungary (see Figure 41). Moreover, only 25 percent of BIM’s calibrations were performed for commercial calibration laboratories (primary calibrations), the rest were for final industrial users (secondary calibrations). Although Bulgaria performs better than Hungary and Turkey, its share of primary market calibrations is lower than in Poland and other EU countries. Although, in part, this is likely to be due to an underdeveloped commercial calibration market, the subsidized fees offered

by BIM may be stifling growth in that market.

BIM’s is mostly focused on providing calibration services and offers few services to disseminate its metrological expertise throughout the economy. In countries with fully developed metrology systems, the NMI disseminates metrological expertise by offering specialized technical consultancy and training services to industry, research institutions, and educational institutions. In contrast, BIM offers very few training services and no consulting services (see Figure 42). BIM has little incentive to offer these because as a government agency, its revenues from services are transferred to the state budget. The legislation regulating the activities of civil servants restricts BIM’s staff from offering consulting services, since these are not considered administrative services.

Figure 41: The Bulgarian national metrology institute provides relatively few calibration services and only a small share is provided to commercial calibration laboratories Bulgaria

Hungary

Turkey

Turkey

Poland

Bulgaria

Hungary

Poland 0 10,000 20,000 30,000 Number of Calibrations

0% 25% 50% 75% % of calibrations to commercial calibration labs

Source: World Bank survey of national metrology institutes.

Note: 2006 data used for Bulgaria, 2005 data used for all other countries.

NMIs conduct R&D to implement new metrological systems, and to deepen their technological capabilities and their ability to offer technical assistance to the private sector. Among 26 mostly European NMIs, all signatories of the CIPM MRA, about 32.5 percent of their annual budget was spent on R&D on average (MacDonald 2001). In 2006, BIM spent only 12 percent of its budget on R&D. Although this is below the average, it is higher than in Hungary or Poland and should be adequate for BIM to it retains the technological capabilities to meet the needs of the economy, given Bulgaria’s level of industrial development (see Table 22).

BIM maintains national measurement standards that are highly accurate and cover most fields of scientific metrology (see Figure 43). Nineteen percent of BIM’s measurement standards are primary standards, meaning that they are the most exact types of measurement standards and provide an absolute basis of reference. The remaining standards are secondary standards that need to be eriodically calibrated against primary standards in other countries.57 In sum, the scope and accuracy of the national measurement standards provided by BIM is in line with Bulgaria’s current needs.

Nonetheless, it is likely that more investment will be necessary in the future to meet the needs of Bulgaria’s rapidly growing economy.

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Chapter 4: Standards and Quality

Figure 42: The Bulgarian national metrology institute provides few training, technical assistance or consulting services Bulgaria

32

Bulgaria

140

Bulgaria

0

Hungary

96

Hungary

80

Hungary

24

Turkey

33

Turkey

Turkey

1304 4280

Poland 0

2,000

269

Poland

4,000 6,000

1273 0

500 1,000 1,500

Poland

1285 0

500

1,000 1,500

Hours of training provided People trained Services provided Source: World Bank survey of national metrology institutes.

Note: 2006 data used for Bulgaria, 2005 data used for all other countries.

Table 22: R&D investments at Bulgaria’s national metrology institute are aligned with regional norms Share of NMI budget spent on R&D (%)

Turkey

Bulgaria

Hungary

Poland

40

12

5

2

Source: World Bank survey of national metrology institutes.

Note: 2006 data used for Bulgaria, 2005 data used for all other countries.

Resources for Metrology Figure 43: Number of calibration fields offered at national metrology institutes and share of primary standards in the stock of national measurement standards Chile

Bulgaria

Hungary Poland

Hungary

Bulgaria Korea

Poland

Turkey Mexico

Turkey

0 5 10 15 20 0% 25% 50% 75% 100% Number of Calibration Fields % of primary standards Source: World Bank survey of national metrology institutes. Note: 2007 data used for Bulgaria; 2006 data used for Turkey, Poland and Hungary; 2005 data used for all other countries.

BIM’s laboratories are currently located in an administrative ofice building in a heavily trafficked urban center. As a result, BIM’s measurements are affected by external vibrations and electromagnetic noise. Because the design and location of the building are unsuitable for the needs of a metrology institute, BIM has been granted land outside Sofia and an architecture firm has been selected for the design of the facilities. Because the tender occurred pre-accession only Bulgarian firms participated, none of who had experience with the design of metrology facilities. As a result, it is not clear that the resulting proposed design reflects the highly specialized needs of a national metrology institute.

Further, less than US$ 7 million was allocated to the development of the new facilities through the Long-term Program for Development of the National Standards of Bulgaria for the period 20042010, adopted by the Council of Ministers. External assessments have concluded that this amount is far too low to meet BIM’s needs.

BIM operates a quality system that is compliant with international standards and several internationally accredited laboratories. It is important for the laboratories of an NMI to adopt a quality management system to guarantee that it is competent to perform specified tests and measurements.

In fact, participation in the CIPM MRA requires this. BIM follows the international standard ISO/ IEC 1702558 as a quality system and has been accredited. Its accreditation will enable it enhance its credibility and facilitates the accreditation of Bulgarian calibration laboratories traceable to BIM.

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BULGARIA: Investment Climate Assessment

Scientific metrology receives financial support at a level comparable to that of industrialized countries in Bulgaria (see Table 23). In fact, the government invests slightly more in metrology than in most industrialized countries. This comparison is biased by the fact that BIM loses the revenues that are transferred to the state budget, while most other NMIs do not. At their current levels, BIM’s revenues would be able to cover 55 to 60 percent of its budget, a higher proportion than in many countries.

Table 23: Bulgaria invests a relatively important amount of resources in metrology Bulgaria Industrialized Mexico Turkey Poland countries * Government investment in metrology (% of GDP)

0.0102

0.002 to 0.007

0.0024

0.0021

0.0015

Source: World Bank survey of national metrology institutes, except (*) based on BIPM (2003).

Note: 2006 data used for Bulgaria, 2005 data used for all other countries and for GDP.

BIM has a very large and technically competent, but underutilized, staff. BIM employs 406 staff members (Table 24), 68 of which work in the scientific metrology laboratories. The number of staff is set in BIM’s regulations, and must be approved by the Council of Minister. BIM is not making the most of its technical personnel to provide calibration services to the private sector. Relative to the size of is metrology staff, BIM provides few calibrations (Table 24). Almost all of the scientific metrology personnel have at least a university degree in science or engineering, ensuring a high level of professionalism. However, BIM is constrained by government salary structures and is not always able to attract or retain the most highly-qualified staff.

Table 24: the Bulgarian national metrology institute has a large number of staff but they are underutilized Bulgaria

Poland

Hungary

Turkey

Total number of staff*

406

404

286

200

Number of accreditations per staff**

49

173

698

36

Source: World Bank survey of national metrology institutes. * 2007 data used for Bulgaria, 2006 data used for all other countries. ** 2006 data used for Bulgaria, 2005 data used for all other countries.

International and Regional Recognition Bulgaria participates in the most important international and regional scientific metrology organizations and has an internationally-recognized measurement system (Table 25). Since 1911, Bulgaria has been a member of the CGPM Metre Convention, the main diplomatic treaty concerning metrology, which recognizes the authority of the International Bureau of Weights and Measures (BIPM) in matters of scientific metrology. Through its membership in the CGPM Metre Convention BIM has also become a signatory of the CIPM MRA when it was created in 1999. As a result, the accuracy and precision of BIM’s measurements, as established through international comparisons, is recognized internationally.

At the regional level, BIM is a member of both the European Collaboration in Measurement Standards (EUROMET) and Euro-Asian Cooperation of Metrological Institutions (COOMET).

Membership in EUROMET and COOMET is particularly useful in that it enables BIM to participate in regional inter-laboratory comparisons that establish the accuracy and precision of its measurements in the context of the CIPM MRA. At the European level, BIM is not a member of EURACHEM, a network organization concerned with the international traceability of chemical measurements and the promotion of good quality practices. Bulgaria is roughly at the same stage of international and regional integration as Hungary and Romania

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Chapter 4: Standards and Quality

Table 25: Bulgaria is a member most international metrological organizations and MRAs International

Bulgaria Chile Hungary Korea Malaysia Mexico Poland Romania Spain Turkey UK

Scientific CIPM CGPM MRA

European

Legal OIMLOIML MAA

EUROMET

Scientific EURA CHEM

Eurolab

Legal WELMEC

EuroAsian

Scientific COOMET

Yes Yes Yes Yes Yes No Assoc.

Yes Yes Yes Yes No No N.A. N.A. N.A. N.A. No Yes Yes Yes No Yes Yes No Yes No Yes Yes Yes Yes N.A. N.A. N.A. N.A. No Yes Yes Corr.

No N.A. N.A. N.A. N.A. No Yes Yes Corr.

No N.A. N.A. N.A. N.A. No Yes Yes Yes No Yes Yes Yes Yes No Yes Yes Yes No Yes Yes Affiliate Yes Yes Yes Yes Yes No Yes Yes Yes Yes No Yes Yes Yes No Yes Yes Affiliate Assoc.

No Yes Yes Yes Yes Yes Yes Yes Yes No Source: BIPM, OIML, EUROMET, EURACHEM, WELMEC, COOMET and Eurolab websites.

Notes: CGPM refers to the Metre Convention; corr. = correspondent member; assoc. = associate member; N.A. = not applicable. June 2007 data.

A number of BIM’s calibration and measurement capabilities (CMCs) are recognized internationally, although a few important measurement areas are missing. Each type of calibration or measurement performed at BIM’s facilities needs to be associated with a CMC, validated by international experts, in order to have its uncertainty recognized by other signatories of the CIPM MRA. A country can extend its scope of approved CMCs by participating in international interlaboratory comparisons.59 Without access to internationally-recognized measurements Bulgarian calibration laboratories would not be able to gain internationally-recognized accreditation and could not disseminate the accurate and precise measurements needed to ensure quality in the private sector. As of May 2007, BIM registered 151 CMCs, the same number as in Romania and slightly less than in Spain (see Figure 44). The vast majority of BIM’s CMCs are in the traditional metrological areas of physics, with very few in the more recent metrological areas of chemistry and ionizing radiation. BIM has established CMCs in all of the most common areas of physical measurement with the notable exception of thermometry, which is useful for a number of industries relevant to the Bulgarian economy, such as food processing, and chemistry, an increasingly important field of metrology. Currently, a number of BIM’s CMCs are at different stages of approval.

Figure 44: Taking into account Bulgaria’s size, it has an adequate number of internationally recognized calibration and measurement capabilities (CMCs), but too few in chemistry Number of CMCs

1200

Physics

Ionizing Radiation

Chemistry

1000 800 600 400

Chile

Malaysia

Bulgaria

Romania

Spain

Poland

Turkey

Hungary

Mexico

Korea

0

United Kingdom

200

Source: BIPM, Appendix C of the CIPM MRA (May 2007).

Legal Metrology in Bulgaria Legal metrology is the shared responsibility of two institutions in Bulgaria, the State Agency for Metrology and Technical Surveillance (SAMTS) and the Bulgarian Institute for Metrology (BIM), which was spun off as a separate agency in mid-2006. SAMTS has a staff of 113 involved in metrological supervision, and 12 regional departments. However, BIM retains some legal metrology functions in the area of type approval, and verification of measuring instruments and fiscal devices.

The division of legal metrology responsibilities across two separate organizations is not common.

Typically, a single organization has full control of legal metrology (see Table 26). In some cases, a single organization is responsible for both legal and scientific metrology.

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BULGARIA: Investment Climate Assessment

Table 26: Bulgaria has unique separation of scientific and legal metrology responsibilities Agency responsible for primary Agency responsible for national scientific metrology national legal metrology institution institution Bulgaria BIM SAMTS Chile INN SERNAC France LN E MINEFE Germany PTB Korea KRISS KATS Mexico CENAM DGN GUM Poland Romania INM BRML Spain CEM Turkey UME Ministry of Industry & Trade United Kingdom NPL NWML Source: BIPM, OIML, EUROMET and WELMEC websites.

Note: data is as of Sept. 2007.

Legal metrology is conducted in compliance with EU requirements. Bulgaria implemented the New Approach directive on Non-Automatic Weighing Instruments 60 into the national legislation.

All remaining voluntary European standards compliant with the New Approach Directives referring to legal Metrology were adopted in 2006 as national standards by the Bulgarian Institute of Standardization (BDS). The 2002 Law on Measurements transposes the Old Approach Directives concerned with legal metrology. Bulgaria has the ability to enforce type approval and verification under the Non-Automatic Weighing Instrument directive through one Notified Body.

Bulgaria is well integrated internationally in the field of legal metrology. Membership in the OIML helps countries harmonize policies that concern the trade of products and services with a commercial value based on measurements, and trade in measuring instruments. Bulgaria is a full member of the International Organization for Legal Metrology (OIML) through BIM (see Table 25).

Furthermore, Bulgaria has signed the newly created OIML Mutual Acceptance Arrangement (MAA), and thus accepts the measuring instruments type approval test reports and certificates issued by issuing participants of the OIML-MAA. This allows Bulgarian firms to develop or use measuring instruments which have been approved in other countries, thereby decreasing technical barriers to trade in an area of importance to technology adoption (i.e. imports of measuring instruments), and allowing domestic firms to rely on testing facilities of other countries where adequate facilities do not exist in Bulgaria in an area of importance to innovation (i.e. instrument design). Bulgaria is also a member of the European Cooperation in Legal Metrology (WELMEC), where most of the practical harmonization of legal metrology activities in Europe takes place. OIML and WELMEC regulations allow for countries to be represented through only one national member, hence SAMTS cannot gain from membership in those organizations.

Policy Recommendations Formulate a strategy for BIM’s transition from the secondary calibration market to the primary calibration market. Most of BIM’s calibrations are provided to the secondary calibration market and it has provided few services to commercial calibration laboratories. BIM could ensure that it is not stifling competition in the market for secondary calibrations. It could consider developing a clear strategy to encourage the creation and use of private calibration facilities and to gradually disengage itself from the secondary calibration market.

BIM could provide training and consulting services to support the diffusion of quality in the private sector. As the prime scientific metrology institution in the country, BIM is aware of best international practices and latest technologies in metrology. However, BIM is not leveraging its technical and scientific expertise to promote the absorption of good practices and innovation in industry. BIM’s regulations might be able to provide incentives for the provision of training and consultancy services.

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71

BIM could be given more autonomy so that it could become more responsive to market needs and bring its operating structure in line with European best practice. BIM cannot adapt its workforce to changing market conditions without amending the national legislation. BIM could have more autonomy on the structure and salaries of its workforce in order to lower overhead costs and hire high-quality technical staff. Furthermore, BIM could be granted the ability to retain its service fees. This would provide it with additional incentives to enhance its efficiency.

Consider whether legal metrology should be the responsibility of a single body, as it is in most European and industrialized economies. There are few qualified metrologists in Bulgaria and they are currently divided between two institutions, SAMTS and BIM. Unifying all legal metrology activities under a single organization would facilitate cooperation within the different legal metrology activities. Unifying legal and scientific metrology would facilitate cooperation between all aspects of legal metrology and scientific metrology. Furthermore, under a single agency, all aspects of metrology would be represented in international organizations such as OIML and WELMEC. The government might consider transferring all legal metrology functions (including enforcement) to BIM, given its existing technical expertise in scientific metrology.

Ensure that the scientific metrology facilities are able to meet international design norms.

The Government could invest in facilities that are suited for the activities of a national metrology institute and do not compromise the effectiveness of BIM’s operation. Bulgaria could take advantage of international experience in the design and construction of metrology facilities to ensure the sustainability of any long-term investment in new facilities.

VII. Standardization Standardization Activities Bulgaria has a large and rapidly-growing stock of voluntary standards.

Te BDS standards catalogue lists 26 954 standards, slightly fewer than in Romania and Turkey, but more than in most other countries, including the United Kingdom and Korea (see Figure 45). The standards stock has significantly grown in the past few years (up from 15,257 standards in 2000).

About 1,621standards were adopted in 2005 alone.

Number of Standards

Figure 45: Bulgaria has a large standards catalogue, most of which are regional standards 30000 25000 20000 15000 10000 5000 0

Bulgaria Romania

Turkey

number of standards based on international standards

United Kingdom

Malaysia

Chile

number of standards based on regional standards

number of purely national standards

Source: World Bank survey of standardization Bodies, ISO (2006) Survey of ISO Members.

Note: June 2007 data used for Bulgaria; Jan. 2006 data used for Romania and Turkey, Dec. 2004 data used for Malaysia; Dec. 2003 data used for the UK; Dec. 2002 data used for Chile.

One reason for this is that Bulgaria has adopted European standards and removed conflicting standards to fulfill requirements for joining the regional standards bodies, CEN and CENELEC, and integrating the European Union. The country has made remarkable progress in its adoption of European standards. European standards constitute almost 60 percent of Bulgaria’s standard stock (see Figure 45) and Bulgaria has adopted more than 90 percent of European Standards.

Many ENs, however, have been adopted in English and have not been translated into Bulgarian.

The Law on National Standardization 61 does not require European standards to be translated. This creates difficulties for businesses and for Notified Bodies in understanding the content of many standards that are used to comply with EU directives.

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BULGARIA: Investment Climate Assessment

Bulgaria has implemented all New Approach and Old Approach EU Directives and has eliminated existing technical regulations. Ministries have transposed and integrated the European legislation related to the Old and New Approaches into the Bulgarian legal system and have removed conflicting technical regulations. However, the number of national technical regulations increased from 219 to 320 between 2000 and 2006, contrary to the practice in other EU accession countries.

In addition to European standards, Bulgaria continues to actively pursue a policy of adopting international standards. Bulgaria had adopted more than 1,900 ISO and IEC standards by January 2006. These represent approximately 7 percent of its standard stock, slightly lower than in most other countries (see Figure 45).

Organization of the Institutional Framework for Standardization The institutional organization standards development underwent significant changes in 2006 and is now similar to that of many other EU countries. The Law on National Standardization, effective May 2006, changed the Bulgarian Institute for Standardization (BIS) from a public agency to an independent non-governmental, non-profit organization. This allows BIS to finance itself from its own revenues and facilitates membership in international organizations. As in most other European countries, BIS is the sole body responsible for the development of national standards and the system is centralized. The organization of standards development in Bulgaria is in line with that of many other countries (see Table 27).

Table 27: Bulgaria’s organization of standards development is similar to that of other EU countries Legal status of primary body Degree of centralization for voluntary standards Chile Private Hybrid Mexico Public Decentralized Korea Public Hybrid Spain Private Centralized UK Private Centralized Turkey Public Centralized Romania Private Centralized Hungary Public Centralized Bulgaria Private Centralized Its privatization had made BIS more autonomous and its administrative structure has been overhauled to include non-state stakeholder representation. As of May 2006, BIS has become the most autonomous of the national quality infrastructure institutions in Bulgaria. The Law on National Standardization provided BIS with a General Assembly of members, of which only 20 percent are government representatives. The General Assembly is the supreme body of the BIS and elects a Managing Board, which in turn takes key governance decisions and elects the Executive Director. Through this transformation, BIS’ administrative structure now conforms to what is found in most other countries (see Table 28).

Relative to its size, Bulgaria dedicates significant resources to standardization activities. In 2005, BIS devoted about US$ 868,000 and 75 staff members to standardization activities. For both financial resources and staff dedicated to standards development, Bulgaria appears to devote more resources than other countries (See Figure 46. This might be due to the limited potential for economies of scale in Bulgaria, because of the country’s small size.

Table 28: Bulgaria’s governance structure for standardization is now in line with other countries’ General Consultative % of executive council Executive director assembly council reserved for governappointed by ment appointees government Bulgaria (2005) Bulgaria (2007)

No Yes

Yes Yes

100% 20%

Yes No

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73

General assembly

Consultative council

% of executive council reserved for government appointees

Executive director appointed by government

Yes No Yes Yes Yes Yes Yes

Yes Yes No No Yes No Yes

0% 100% 0% 55% 0% 33% 5%

No Yes No No No No No

Mexico* Korea Spain Turkey UK Hungary Romania

Note: *refers to voluntary standards bodies only.

Resources for Standardization Figure 46: Bulgaria’s national standards body has more financial and human resources than in most other countries Source: World Bank survey of standards bodies.

Turkey

Romania

Hungary Chile

Turkey

Romania

Bulgaria

Bulgaria

0

10

20

30

40

0

Standardization budget (% of GDP)

1

2

3

Staff per US$ billion of GDP

Note: For figure on left, 2006 data used for Bulgaria; 2005 data used for other countries. For figure on right, 2007 data used for Bulgaria, 2002 data used for Chile, 2006 data for all others.

The Law on National Standardization stipulates that BIS can raise revenue from government subsidies and related funds, membership fees, sales of standards, conformity assessment and training services and donations. Conformity assessment services are often an important source of funding for standardization bodies. BIS currently does not offer any conformity assessment services. National standards bodies which do not raise revenue through conformity assessment services typically are not able to cover their costs from standards publications and membership fees alone and must depend on Government subsidies for part of their budgets (see Figure 47).

Nonetheless, relative to the size of its economy, Bulgaria is efficient in generating revenues from the standards development process (see Figure 48).

Figure 47: Government transfers account for a large share of Bulgaria’s standardization budget 75% 50%

public transfers

standards publications

membership fees

certification

Turkey

Romania

United Kingdom

Chile

Spain

Bulgaria

Poland

0%

Malaysia

25%

South Korea

% of revenues

100%

other

Source: ISO Members (2006), World Bank survey of standardization bodies.

Note: 2006 data used for Bulgaria, 2005 data used for all other countries.

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BULGARIA: Investment Climate Assessment

Figure 48: Bulgaria is relatively efficient at raising revenues from standardization activities rev. from standardization (per US$ million of GDP)

30

20

10

0

United Bulgaria Hungary Romania Spain Kingdom

Chile

Turkey

Source: ISO Members (2006), World Bank survey of standardization bodies.

Note: 2006 data used for Bulgaria, 2005 data used for all other countries.

Participation in international standards development Bulgaria is a full member all major international and European standardization organizations.

Bulgaria is a full member of ISO, IEC, ITU, CEN, CENELEC and ETSI (Table 20). It has the right to adopt, diffuse and participate in the development of their international and regional standards.

Prior to 2007, Bulgaria was only an affiliate member of CEN and CENELEC, and had limited input in their standards development process.

As of May 2007, Bulgaria was a participant-member in 83 ISO committees out of a total of 733. This represents slightly fewer committees than Romania or Turkey, which is expected given Bulgaria’s smaller size (see Figure 49). However, Bulgaria, has no technical secretariats or governorships, and is not playing a leading role in international standardization (see Figure 49).

International standardization participation costs are high and an economy of the size of Bulgaria cannot be expected to compete with larger economies in this area, but this activity has important effects on Bulgaria as most of its trading partners use international standards.

Table 29: Bulgaria is a member of most international standards bodies Country

International

European

ISO*

IEC**

ITU***

CEN*

CENELEC**

ETSI***

Bulgaria

Yes

Yes

Yes

Yes

Yes

Yes

Chile

Yes

No

Yes

N.A.

N.A.

N.A.

Hungary

Yes

Yes

Yes

Yes

Yes

Yes

Korea

Yes

Yes

Yes

N.A.

N.A.

N.A.

Malaysia

Yes

Yes

Yes

N.A.

N.A.

N.A.

Mexico

Yes

Yes

Yes

N.A.

N.A.

N.A.

Poland

Yes

Yes

Yes

Yes

Yes

Yes

Romania

Yes

Yes

Yes

Yes

Yes

Yes

Spain

Yes

Yes

Yes

Yes

Yes

Yes

Turkey

Yes

Yes

Yes

Affiliate

Affiliate

Yes

UK

Yes

Yes

Yes

Yes

Yes

Yes

Source: ISO, ITU, IEC, CEN and CENELEC websites.

Note: *general standards, **electro-technical standards, ***telecommunications standards; affiliate members do not have the right to vote on standards. Data is as of May 2007.

Chapter 4: Standards and Quality

75

Figure 49: Bulgaria participates in approximately as many ISO committees as other small EU accession countries, but holds no ISO committee secretariats/working group governorships Chile

participant observer

Mexico

Bulgaria Romania

Bulgaria

Number of govenorships (WG) Number of secretariats (TC/SC)

Mexico

Turkey

Chile

Hungary

Hungary

Malaysia

Turkey

Romania

Malaysia

Poland

Poland

0

200 400 600 ISO Committee membership

0 5 10 15 % of secretariats or governorships

Source: ISO 2005 Annual Report (2006).

Policy Recommendations Obsolete standards could be removed. Bulgaria has a very large standard stock. Moreover, many older Bulgarian standards that were developed prior to BIS’ restructuring and without using international best practices coexist with new standards. Some of these standards may hamper flexibility and technology upgrading in the private sector. BIS could increase efforts to systematically review its national standards to reduce its outsized standard stock.

Although it is important to continue to adopt European and international standards, it would be useful to make sure that there are effective processes to translate them into Bulgarian and to provide English training to conformity assessment personnel. A strategy for the translation of its English-language EN standards that places priority on the most important standards and formulate a definitive timeline for the translation of all standards of relevance to the Bulgarian economy, in consultation with private and public stakeholders, could be adopted. It should establish clear obligations for ministries to fund the translation of harmonized standards that fall under New Approach directives under their responsibility. English training needs to be provided to conformity assessment personnel, expected to work with standards that hove not yet been translated.

Support participation of the private sector in European and international standardization activities. Membership in the European standards bodies and active participation in the work of technical committees will allow Bulgaria to provide its inputs to the regional standards that it adopts.

It can be difficult for firms, especially Bulgarian SMEs, to represent interest in CEN, CENELEC, ISO and IEC technical committees due to high travel costs unless participation in these organizations is supported by public funding.

Chapter 5: Perceptions about the Investment Climate The Enterprise Survey does not just collect information on firm performance and innovation. It also collects information on the investment climate—including topics such as corruption, competition from the informal sector, instability, and worker education and skills. The questionnaire includes two types of questions: (i) subjective questions about what managers see as the major problems that they face; and (ii) objective questions that try to measure investment climate constraints in terms of time, money and other quantitative information. For example, firm managers are asked subjective questions about how great an obstacle electricity supply, access to finance and government regulation are to their business, but are also asked how much production is lost because of power outages, whether their firm has a loan or overdraft, and how much time they spend dealing with government regulations and inspections. The ICA uses both types of information—and supplementary information from other sources—to assess investment climate related constraints to enterprise operations and growth in Bulgaria and to compare constraints in Bulgaria with constraints in the comparator countries. This chapter, however, focuses on the subjective questions.

I. Perceptions about Constraints to Enterprise Operations and Growth As a starting point for the analysis of the investment climate, this chapter looks at what enterprise managers say are the biggest obstacles that they face. Since enterprise managers know more about the immediate problems facing their businesses than government officials, academic researchers, or other outside experts, it makes sense to take their concerns about the investment climate seriously.

Although it is important to do this, it is also important to realize that perceptions are not a perfect measure of the investment climate. First, it is difficult to aggregate perceptions across firms. Constraints affect different firms to different degrees and perception-based data cannot be aggregated as easily as objective data (for example, costs measured in local currency). This makes it difficult to rank obstacles. For example, it is not clear whether an issue that one firm considers a very serious problem and another firm considers a minor problem, is more or less of a problem on aggregate than one that both consider a moderately serious problem. Because of these concerns, in addition to using objective data in later chapters of the Investment Climate Assessment, this chapter looks at two measures of perceptions; the share of firms that say whether an issue is a serious problem and the share that say it is the biggest obstacle that they face. This makes it possible to check that the results based upon the perception-based indices are robust to small changes in the way the question is asked.

Second, although managers may be aware of a problem, they might not be aware of the underlying causes. For example, they might know that it is difficult to get bank loans to finance new investment, but might not know the underlying reasons for this (e.g., lack of competition in the banking sector, government debt issues crowding out private investment, or problems with land registration that prevent firms from using land as collateral). As a result, additional information is needed to assess how to release any given constraint.

Third, enterprise managers’ interests might not always be consistent with society’s interests. Most managers would like subsidized credit or to be charged less for electricity or water if they believed that the cost of providing these services would be borne by someone else. Similarly, most managers would be happy to face less competition even if the cost to society outweighed the benefits to their firm. It is important, therefore, to keep the costs of interventions in mind and to think about how policy changes will affect other stakeholders (e.g., workers and taxpayers) before adopting programs to reduce constraints.

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Fourth, the views of managers of existing enterprises might not reflect the obstacles that potential entrepreneurs and new entrants might face. For example, managers of existing enterprises that have already completed registration procedures might not be concerned about entry costs even if they remain high. Further, they might rate some issues as lesser problems because they have structured their businesses in ways to minimize those costs. For example, if transportation costs are especially high in some areas, existing firms might only be located close to transportation facilities or might provide their own transport. This does not mean that improving transportation would not be useful.

Finally, if investment climate constraints are particularly binding, then there might be very few firms that rely heavily upon that area of the investment climate.62 For example, if the ports and custom facilities are particularly poor, very few firms might operate in export-oriented industries. It is important, therefore, to think about how constraints might affect new and potential entrants as well as how they affect the managers of existing firms interviewed during the survey.

Finally, cultural differences or persistent differences in expectations about how the investment climate should look might affect perceptions. For example, expectations about political freedom and freedom of speech might affect whether managers are willing to complain to interviewers about the investment climate more than it affects their willingness to answer objective questions.63 This can make cross-country comparisons of perception-based data difficult.

Although the concerns about perception-based data are serious, it is important not to overemphasize these problems. Recent work suggests that perception-based measures line up reasonably well with objective macro- and micro-economic indicators even on a cross-country basis.64 That is, despite concerns about subjective measures, they seem to provide useful information.

But because of these concerns, although this assessment uses the perception-based data as a starting point for the analysis, this information will be supplemented with objective measures of the investment climate taken from the Enterprise Survey and other sources when possible and appropriate. In addition, although cross-country comparisons of perception-based data (e.g., comparing the number of firms that complain about an issue between countries) can provide some context to results using objective data, concerns about cross-country comparisons of perceptions will mean that the later chapters will mostly use objective data for cross-country comparisons when this information is available.

II. Main perceived constraints The Enterprise Survey asks firm managers to say how great an obstacle of each of 15 areas of the investment climate is to the current operations of their business. They respond by rating each on a five-point scale between ‘no obstacle’ and a ‘very severe obstacle’. Figure 50 shows the percent of each type of firm that rated each area as a ‘major’ or ‘very severe obstacle’. Throughout the report, if firm managers rate an obstacle as ‘major or very severe’, it will be described as the firm manager saying it is a ‘serious obstacle.

Figure 50: Firms are most likely to be concerned about corruption, instability, competition with informal firms and worker skills and education

% of firms saying issue is serious problem

60%

40%

20%

Trade Regulation

Transportation

Finance

Labor Regulations

Business Licensing

Land

Electricity

Courts

Tax Administration

Source: World Bank Enterprise Survey (2007).

Crime

Tax Rates

Worker Education

Informal Competitors

Instability

Corruption

0%

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79

Informality and corruption ranked among the top concerns of firms. As discussed in Chapter 1, informality does appear to be relatively high in Bulgaria—at least compared to the most other new EU entrants and to most high-income countries in the EU. But it is important to note that corruption and practices of competitors in the informal sector should both be seen as symptoms of underlying problems rather than as problems that can be dealt with directly. Many studies have emphasized that both can reflect problems related to regulation and taxation. High levels of regulation and taxes can encourage firms to remain informal and can also encourage corruption as firms try to avoid them. As discussed in detail in Chapter 6, although tax rates have been reduced, the burden of regulation remains very high. In fact, firms estimate that managers spend about 17 percent of their time dealing with requirements related to government regulation.

The area of the investment climate that firms were second most likely to say was a serious problem is political instability. This is puzzling. When firms are worried about political instability, this often brings to mind the idea that they are concerned about their property rights during violent uprisings such as coups or revolutions. It is clear that these are not significant concerns in a country such as Bulgaria—a new member of the European Union.

A more likely interpretation is that managers are concerned about instability in the policy environment. When regulations and policies change quickly or unpredictably, it is difficult for manager to make long-term plans. Given the large changes in regulation and economic policy that the Government has had to enact over a relatively short period to join the European Union, it might not be surprising that managers are concerned about this type of instability. Even though some of the changes, such as those to comply with EU requirements, might be predictable in the sense that regulatory experts might know what needs to be done, it is difficult for small business owners to collect enough specific information to easily understand the likely changes. That is, it might be difficult for both managers and regulators to stay on top of regulatory changes and this might, in turn, increase concern about the predictability of policy.

Other evidence from both the Enterprise Survey and from other sources suggest that it is this kind of policy instability that is the major concern and not political instability per se.

•

Even in recent surveys, when asked directly about government instability/coups in the Global Competitiveness Report (Porter and others, 2007), very few firms said it was a problem. In fact, it ranked as the second least significant constraint out of a list of 14 possible constraints with only foreign currency restrictions ranked lower. This strongly suggests that it the stability of the government and political system and the potential for political violence are not serious concerns for most firms.

•

On previous recent surveys (e.g., BEEPS 2005 and the Enterprise Survey from 2004) where firms were asked directly about regulatory instability, it has usually ranked among the top constraints. Since this question was omitted in the most recent Enterprise Survey, this suggests that the broader question from the 2007 survey is catching some of the narrower concern about regulatory and policy instability.

•

Other evidence from the Enterprise Survey suggests that there is concern about stable and predictable regulation. In a separate question, firms are asked whether they agree or disagree with the statement that ‘Government officials’ interpretations of the laws and regulations affecting this establishment are consistent and predictable’. About 75 percent of firm mangers either strongly or tended to disagree with the statement. Moreover, there is a strong correlation between firm managers’ perceptions about instability and their views on how consistent and predictable regulations were. That is, firms that complained about instability were also likely to complain about unpredictable enforcement of regulation.65

This suggests that the most consistent way to interpret this question would be that Bulgarian firms are more concerned about the stability of policy and regulation rather than being concerned about the possibility of political violence or non-constitutional change of government.

In addition to these three areas, about one-third of enterprise managers said that worker education and skills were a serious problem—slightly lower than the share that said corruption, instability, and competition from the informal sector were serious problems. About one-quarter said tax rates and crime were serious problems, while fewer said other areas of the investment climate were serious constraints. Very few said customs and trade regulation were a serious problem.

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As well as being asked to rate each obstacle on a five-point scale, managers were also asked what was the biggest constraint they faced. Although in most cases, results from the two questions are similar, there can be differences. If a small number of managers feel very strongly about an issue while the majority is more ambivalent, it is possible that that issue might not rank among the top constraints based upon the previous question while ranking among the top constraints based upon the question about the biggest constraint.

Figure 51: The top four concerns are the same for the question on the biggest constraint as in the previous question Other 28%

Finance 9%

Informal competitors 19%

Instability 18% Corruption 13%

Worker education 13%

Source: World Bank Enterprise Survey (2007).

Note: ‘Other’ includes firms that responded ‘Don’t Know’ (about 3 percent of total).

In practice, the responses to the questions are fairly similar. In particular, the four areas of the investment climate that firm managers were most likely to say were the biggest problems are the same as the four areas that firms were most likely to say were a serious problem (competition from the informal sector, instability, worker education and corruption).

There were, however, some differences. Most notably, although relatively few firms said that access to finance was a serious problem (only about 20 percent of firms, making it the 12th greatest constraint by that measure), a fairly significant number ranked it as the biggest constraint that they faced (about 9 percent making it the fifth biggest constraint by this measure). Second, although firms were more likely to say that corruption was a serious problem than any other area of the investment climate, it only ranked fourth based upon the second question. This suggests that although there is fairly wide concern about corruption, concern is not as deep as about the other areas.

III. Differences in perceptions between different types of firm Managers of different types of enterprises often have very different perceptions about the investment climate and the major constraints that they face. These differences could be due to differences in expectations (e.g., foreign-owned firms might have expectations based upon their experience in their home countries) or differences in experiences (e.g., large firms might find it easier to get loans due to having better connections or better access to collateral).

This section focuses on differences in perceptions across different types of firm. Later chapters look at whether the differences in objective indicators are consistent with the differences in perceptions.

This section focuses on differences that are both economically and statistically significant (i.e., that are both important in terms of size and that do not appear due to sampling variation). A fuller discussion of the econometric methodology and additional results are presented in detail in Appendix 5.1.

Worker skills and education About 13 percent of firms said that inadequately educated workers were the most severe constraint on their firm and about 34 percent of firms said it was a serious constraint. This makes it the third largest constraint by the first measure and the fourth largest by the second measure.

Worker education, however, is a more serious constraint on some firms than others. Whereas only about 30 to 40 percent of firms in retail trade, manufacturing, and other services said that inadequately educated workers was a serious constraint, close to two-thirds of firms in the IT sector said the same.66 Moreover, over one-third of IT firms said that it was the biggest constraint they faced.

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81

Fewer managers in the manufacturing sector said that skills were a serious constraint than in the IT sector. They were also no more likely to say that skills were a problem than in the retail trade and services sectors.67 This, however, obscures differences within manufacturing. In the garments sector—a sub-sector that is not highly skills-intensive—only about 30 percent of firms said that inadequately educated workers were a serious constraint. In the machinery and equipment sector, over one-half of managers said the same. In general, managers in those sub-sectors that hire less well-educated production workers (garments, food, and fabricated metal products) were less likely to say that skills is a problem than managers in sub-sectors that demand better educated workers (e.g., electronics and machinery and equipment). Other evidence is also consistent with this. Firms that are more innovative (e.g., that introduced new products or production processes between 2004 and 2007) were almost three times as likely to be concerned about worker skills and education than less innovative firms that did not do so (45 percent compared to 16 percent).

70% 60% 50% 40% 30% 20% 10% Machinery and Equipment

Electronics

Fabricated Metal Products

Food and Beverage

Garments

Information Technology

Retail Trade

Manufacturing

0% Other Services

% of firms saying worker education is a serious problem

Figure 52: Inadequately educated workers are a particular concern in the IT areas and in some sub-sectors of manufacturing

Source: World Bank Enterprise Survey (2007).

In summary, inadequately educated workers tend to be a more serious constraint in skills- and innovation-intensive sectors. This suggests that attempts to move up the value chain into more sophisticated production areas is likely to be complicated by the availability of skilled workers, stressing the need to release these constraints.

Access to Finance Previous cross-country analyses have shown that two areas of the investment climate appear to be a particular concern for small firms—access to finance and access to land.68 Of the 27 countries covered in the most recent BEEPS survey in 2005, small companies were more likely to be concerned about access to finance in 21 of the 27 countries (see Figure 53). As in 2005, the recent Enterprise Survey shows that small firms in Bulgaria were more likely to say that access to finance was a serious problem than medium and large firms were. Whereas about 22 percent of managers of small firms said access to finance was a serious problem, only about 15 percent of managers of medium and large firms said the same.

But overall, access to finance does not seem to be a primary problem even for small firms. Although managers of small firms were more likely to say that access to finance was a serious problem than managers of large firms, it did not rank among the top concerns of small firms, according to the recent survey. Based upon the percent of firms that said whether that area of the investment climate was a serious problem, it only ranked as the 12th most serious concern.

Managers of manufacturing firms were more concerned about access to finance than other managers—even after accounting for other differences between manufacturing and other firms.

About 27 percent of managers of manufacturing firms said that access to finance was a serious obstacle compared to between about 13 and 25 percent of managers in the other three sectors.

Despite this higher level of concern, it did not rank among the top concerns even for managers of manufacturing firms (7th of the 15 areas based upon percent of firms that said it was a serious problem).

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Figure 53: Managers of small firms are more likely to be concerned about access to finance in most countries in Europe and Central Asia 60%

Small Medium/Large

% of firms saying area is a serious problem

50% 40% 30% 20% 10%

Latvia Tajikistan

Azerbaijan Slovakia

Slovenia Estonia

Kazkhstan Belarus

Macedonia Armenia

Czech Uzbekistan

Romania Kygyzstan Bosnia

Russia Albania

Georgia Ukraine

Lithuania Croatia

Hungary Bulgaria

Poland Moldova

Serbia Turkey

0%

Source: BEEPS surveys, including Bulgaria (2005).

Note: Small firms have fewer than 50 employees and Medium/Large firms have 50 or more employees.

Competition with the Informal Sector Firm managers in Bulgaria were more likely to say that competition with firms in the informal sector was their biggest problem than they were to say the same about any other area of the investment climate (see Figure 51) and were more likely to say it was a serious problem than any other area except corruption and instability (see Figure 50). As in many countries, however, competition with informal competitors was a far more serious concern for small firms than it was for larger firms.

Whereas over 44 percent of managers of small firms said it was a serious obstacle only 18 percent of managers of large firms said the same (see Figure 2). Moreover, based upon the number of firms that said it was a serious problem, it ranked as the second greatest concern for managers of small firms but only the seventh greatest for managers of large firms.

Figure 54: Large firms and firms in the IT sector are less concerned about competition with informal firms than other firms are Retail

Retail Trade

Manufacturing

Manufacturing

Other Services

Other Services

I.T.

I.T.

Small

Small

MediumSized

MediumSized

Large

Large

0% 10% 20% 30% 40% 50% % saying informality is a serious constraint

Source: World Bank Enterprise Surveys (2007).

80 85 90 95 100 % of revenue reported to tax authorities

The greater concern of managers of small firms might reflect that small firms are more likely to find themselves in direct competition with informal firms, which are often very small and are not usually capital intensive (i.e., because it is easier for small, labor-intensive firms to remain below the radar). It might also be because small firms are more concerned about the informal behavior of formal or semi-formal competitors than large firms are. For example, they might be concerned about tax compliance by their formal competitors. In practice, the evidence for this appears relatively weak. Although managers of small firms reported lower levels of tax compliance than managers of larger firms, all managers reported relatively high levels of compliance and the difference was not statistically significant.69 Moreover, small firms were no more likely to say that they were in competition with informal firms than large firms were (see Chapter 1).

Chapter 5: Perceptions about the Investment Climate

83

Another difference was that managers of IT firms were less likely to say that competition from firms in the informal sector was a serious problem than firms in other sectors. Whereas only 19 percent of managers in the IT sector said that competition with informal firms was a serious constraint, close to 40 percent of other managers said the same. Moreover, competition with informal firms only ranked as the 9th greatest constraint for firms in the IT sector, but in the top three constraints for firms in the other three sectors. This is consistent with the evidence from Chapter 1 where few IT firms reported that they were in competition with informal firms.

Crime In most countries where retail firms have been surveyed as part of an Enterprise Survey, retail firms tend to be particularly concerned about crime.70 Retail firms usually stock goods for final consumption by consumers—meaning that it will often be both useful to the person who stole it and can be easily re-sold. Moreover, retailers have to provide consumers access to their goods (e.g., on shop shelves). In contrast, many goods that manufacturing companies hold are of little use to end consumers (e.g., intermediate inputs, parts, capital machinery and equipment) and might be more difficult to sell. Moreover, consumers are generally not provided access to the factory floor or facilities in the same way that that they are provided access to retail shops. This will make it more difficult to steal from manufacturers than from retailers.

Consistent with this and with the experience in other countries, managers of retail firms in Bulgaria appear more concerned about crime than managers of firms in other sectors. About 42 percent of managers said crime was a serious problem—more than any other areas of the investment climate except corruption (52 percent of managers) and competition with informal firms (43 percent of managers). In contrast, crime did not rank among the top concerns of managers of firms in other sectors, with only between 25 and 30 percent of managers saying that it was a serious obstacle.

Business Registration Firms in the ‘other services’ sectors were more likely to say that business registration and licensing were serious problems than firms in other sectors were. About 25 percent of managers in this sector said that business registration was a problem compared to about 6 and 21 percent of managers in the other three sectors. But even among other service firms, business licensing did not rank among the greatest concerns. Based upon the percent of firms that said each area was a significant problem, it only ranked 8th of 15 areas for firms in this sector.

30% 25% 20% 15% 10%

Garments

Electronics

Fabricated metal

Food

Machinery

I.T.

Retail

0%

Manufacturing

5% Other Services

% of firms saying worker education is a serious problem

Figure 55: Business registration is a greater concern for firms in the ‘other services’ sector and in some sub-sectors of manufacturing

Source: World Bank Enterprise Survey (2007).

Although it would be interesting to break down the figures for ‘other services’ further, there are few firms—typically less than 10—in most subsectors. In contrast, the manufacturing sub-samples tend to be larger. Managers of firms in the food processing and machinery sub-sectors were more likely to say that business licensing was a serious problem than managers in other subsectors (see Figure 55). A recent report noted that the registration process for food business operators is particularly cumbersome, with processing firms having to register with municipalities, the Ministry of Health and the Ministry of Agriculture.71

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BULGARIA: Investment Climate Assessment

IV. Comparisons with results from previous surveys Firms have been asked about their views about the constraints that they face in several earlier studies, including a 2004 Enterprise Survey and the 1999-2005 Business Environment and Enterprise Performance Surveys (BEEPS).72 Comparisons with these earlier surveys can give some information on how the investment climate has changed over time.

Comparisons are complicated by several factors, however. First, differences in sample frames can make it difficult to compare results from different surveys. For example, the 2004 Enterprise Survey covered only manufacturing, construction, hotels and restaurants, and transport and communications. While the BEEPS surveys cover the entire economy, the surveys included quotas for various enterprise types meaning that the samples are not necessarily fully representative.

Neither survey contains weights.

Second, the different surveys often ask questions on perceptions about the investment climate in different ways. Lists of areas usually differ between surveys.73 Moreover, in many surveys—although not the earlier enterprise surveys or the BEEPS survey—questions about the perceptions are only asked as questions about the biggest constraint rather than about the severity of constraints or in both ways as in the Enterprise Survey.74 Even when firms are asked to rate obstacles on a scale (e.g., from ‘no’ obstacle to ‘very severe’ obstacle), the scales are often different and often have different descriptions.75 Although this means that comparisons should be treated carefully, these comparisons are still useful. As discussed above, although there are some differences by firm type, firms in different sectors and of different sizes often have common concerns. In this respect, although the comparisons are not perfect, it seems useful to at least consider them.

The 2005 Business Environment and Enterprise Performance Survey (BEEPS III) In 2005, the European Bank for Reconstruction and Development (EBRD) and the World Bank conducted the third BEEPS survey in 27 low and middle-income countries in Europe and Central Asia including Bulgaria. A total of 9655 firms were interviewed in the 27 countries, with about 300 firms interviewed in Bulgaria. The questionnaire was also similar to the Enterprise Survey in many ways, including many of the same questions as in the core Enterprise Survey that was being used by the World Bank at that time. Although the 2007 version of the Enterprise Survey is slightly different from the 2005 version of the Enterprise Survey (including in how some of the obstacles were described), this means that the two questionnaires are fairly similar.

There were, however, some minor differences. For example, there were a few differences in how questions were worded. The BEEPS survey asked about the skills and education of available workers rather than inadequately educated workers and asked whether each obstacle was an obstacle to the ‘operations and growth’ of the business rather than about the ‘operations’ of the business. The BEEPS questionnaire included additional questions on whether macroeconomic instability, land titling, organized crime, and anti-competitive practices of other firms were obstacles to the firms’ operations and growth.

But there were also some more significant differences. One notable difference was that the BEEPS questionnaire asked about access to finance (collateral) and cost of finance (interest rates) separately.

It also omitted the survey question on ‘political instability’ and ‘practices of competitors in the informal sector’, two of the top concerns in the 2007 survey. Although the BEEPS questionnaire included a question on uncertainty that might be similar to the omitted question on instability, which asked about the uncertainty of regulatory policy, the two questions are different.

Another significant difference between the two surveys is that although most of the obstacles that managers were asked about in the 2005 BEEPS Survey were similar to the obstacles asked about in the Enterprise Survey, the scale was different. In particular, although the first four categories— no obstacle, minor obstacle, moderate obstacle, and major obstacle—are included in the BEEPS survey, the final category used in the Enterprise survey (very severe obstacle) is omitted. Although it seems plausible that most people who would answer ‘very severe obstacle’ might just respond ‘major obstacle’ (the highest category in the 2005 BEEPS survey), research shows that differences in scaling

85

Chapter 5: Perceptions about the Investment Climate

can be very important (Iarossi, 2006). In particular, respondent usually avoid extreme categories.

As a result, it is not possible to compare the percent of firms saying whether each area is a serious problem between the two surveys.

Survey coverage was fairly similar to the survey coverage in the 2007 Enterprise Survey. As in the 2007 Enterprise Survey, the 2005 BEEPS survey covered manufacturing, construction and service firms and did not cover government services; agriculture; electricity, gas and water, or financial intermediation.

There were, however, some differences in coverage. One minor difference was that the BEEPS survey covered mining. In practice, however, this is not likely to make a significant difference in the results for Bulgaria since there were only four mining firms in the sample for Bulgaria. A more significant difference was that quotas were set for various types of firms (e.g., for state-owned firms, foreign-owned firms, exporters, and large firms). Combined with the fact that weights were not constructed for the survey, this means that it is less likely that coverage is representative of the economy in the same way that the sample is for the Enterprise Survey.

Despite the differences in coverage, sampling and questionnaire design, it is important to note that there are some similarities in the results (see Figure 56). Firm managers are not very concerned about most areas of regulation, access to land, and transportation, in either survey. Further, as in the 2007 Enterprise Survey, corruption and tax rates rated among the top constraints—although tax rates were a less notable concern in the 2007 survey and corruption was a more notable concern.

Concern about the judicial system was also relatively high in both surveys. Finally, like instability in the 2007 Enterprise Survey, concern about regulatory policy uncertainty was high in the 2005 BEEPS surey.

40%

Telecommunications

Transportation

Electricity

Access to Land

Crime

Land Titling

Tax Administration

Customs and Trade Regulation

Business Licensing

Organized Crime

Inadequately Educated Workforce

Labor Regulations

Macroeconomic Instability

Access to Finance

Contract Violations

Corruption

Courts

Cost of Financing

0%

Tax Rates

20%

Regulatory Uncertainty

% of firms saying issue is serious problem

Figure 56: In the 2005 BEEPS Survey, firms were most concerned about tax rates, regulatory uncertainty and the cost of financing

Source: Business Environment and Enterprise Performance Survey (2005).

There were some differences between responses to the 2005 BEEPS survey and the 2007 Enterprise Survey. One difference is that concern about worker skills and education was lower in 2005 than in 2007. A second difference is that concern about the power sector was also lower in 2005. A third difference is that concern about crime was higher in the 2007 survey—although this could be due to the separation of ‘organized crime’ from ‘street crime’ in the 2005 BEEPS survey. Finally, Bulgarian firms in 2007 have noted that access to and the cost of finance is much less of concern compared to the survey in 2005, when the cost of finance ranked 3rd among major concerns.

The 2004 Enterprise Survey In 2004, a survey of 548 firms in the manufacturing, hotel and restaurant, and construction and transportation sectors was conducted in Bulgaria. The survey was a modified version of an earlier Enterprise Survey core survey instrument. The survey did not provide weights and was heavily

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BULGARIA: Investment Climate Assessment

weighted towards manufacturing (355 of the 548 firms). The scale for the question was similar to the scale used in the 2007 survey (i.e., a 5-point scale rather than the 4-point scale used in the BEEPS surveys).

The list of constraints was similar to the list of constraints in the 2007 survey. There were, however, a couple of differences. First, like the 2005 BEEPS questionnaire, the survey omitted the question on instability and included questions on economic and regulatory policy uncertainty and macroeconomic instability. Second, the survey included additional questions on whether other areas of regulation were constraints (e.g., price regulation, fire and safety regulation, standards and certification and competition law). None of these additional regulatory areas, however, ranked among the top constraints and so are omitted from the figure below.

There were also some other minor differences in how questions were worded. The most significant differences were that rather than asking about ‘practices of competitors in the informal sector’ and ‘inadequately educated workers’, the 2004 survey asked broader questions about ‘anti-competitive and informal practices’ and ‘skills and education and available workers’.

Figure 57: In the 2004 Enterprise Survey, firms were most concerned about financing, competition with informal firms and regulatory uncertainty

40%

Source: World Bank Enterprise Surveys.

Telecommunications

Electricity

Transportation

Access to Land

Inadequately Educated workforce Tax Administration

Business Licensing

Customs and Trade Regulation Labor Regulations

Courts

Macroeconomic Instability

Tax Rates

Crime

Regulatory Uncertainty

Informal Competitors

0%

Access to Finance

20%

Cost of Financing

% of firms saying issue is serious problem

60%

Because both the 2004 and 2007 surveys use a 5-point scale, it is easier to compare results from this survey with results from the 2007 survey in terms of the number of firms that said each areas was a serious problem. One interesting point is that the level of concern about many of the top concerns appears to have fallen between 2004 and 2007. For example, over half of firms in the 2004 survey said that three constraints were serious problems (cost of financing, access to financing, and informal competitors). In comparison, less than half of firms said that each area of the investment climate was a serious problem for all areas of the investment climate. This suggests that firms were generally more satisfied in 2007 than in 2004 across many areas of the investment climate. Because the BEEPS surveys use a different scale, it is not possible to make similar comparisons between the 2002 and 2007 and 2005 and 2007 surveys.

There were some similarities between the 2004 and 2007 surveys (see Figure 57). Notable similarities between the two surveys included that: (i) informal competitors ranked among the top constraints in both years; (ii) tax rates and crime appeared as serious constraints—although not among the very top constraints—in both surveys; (iii) there were relatively few complaints about transportation or most aspects of regulation in either survey and (iv) concern about instability (regulatory and economic policy uncertainty in 2004 and political instability in 2007) was high in both surveys. The fact that concern about crime was greater in both the 2004 and 2007 Enterprise

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Surveys than it was in the 2005 BEEPS survey might reflect that the 2005 BEEPS survey asked about ‘organized crime’ and ‘street crime’ separately.

There were, however, some differences. One of the most notable is that concern about access to finance was far greater in the 2004 survey than in the two later surveys. In fact, in contrast to the 2007 survey where concerns about access to finance were relatively modest even among manufacturing firms, firms were more likely to say that access to financing and the cost of finance were serious constraints than any other area of the investment climate (see Figure 57). Second, although crime and tax rates ranked in the top five or six concerns in the two surveys, far fewer firms said they were a problem in the 2007 survey—about 40 to 42 percent of firms said that they were serious problems in 2004 compared to only about 28 percent in 2007.

Another difference is that concern about electricity supply increased between 2004 and 2007 Enterprise Surveys. In 2004, less than 7 percent of firms said that power was a serious problem—less than any other constraint except for telecommunications, which was omitted from the 2007 survey.

By 2007, about one-quarter of managers said this was the case. In this respect, results from the 2004 Enterprise Survey are similar to results from the 2005 BEEPS Survey. Second, where few firms complained about worker skills in 2004, it had become a more significant concern by 2005 and 2007. Finally, although concern was not particularly high in 2004 or 2005, concern about trade and customs regulation had fallen significantly by 2007.

The 2002 Business Environment and Enterprise Performance Survey (BEEPS II) The 2005 BEEPS survey, which is discussed above, was the third survey in a series of surveys by the EBRD and the World Bank. The second survey was conducted in 2002. The 2002 BEEPS survey covered fewer firms—only 6,667—in the same countries as in the 2005 survey. There were only 250 Bulgarian firms in the survey, 50 fewer than in 2005. Otherwise survey coverage, including the use of quotas and the lack of weights, was similar in the two surveys.

The questionnaire was also very similar to questionnaire used in the 2005 survey. Although there were some changes—the 2002 survey was longer and had less information on firm productivity—the perception based questions were almost identical to the 2005 survey. The main change was that the questionnaire asked about ‘economic policy uncertainty’ rather than ‘uncertainty about regulatory policies’. Otherwise the discussion about differences in questionnaire and survey coverage for the 2005 BEEPS survey also applies to the 2002 BEEPS survey.

80% 60% 40%

Customs and Trade

Access to Land

Transportation

Telecommunications

Land Titling

Labor Regulations

Inadequately Educated Workforce Electricity

Tax Administration

Business Licensing

Courts

Crime

Contract Violations

Organized Crime

Corruption

Tax Rates

0%

Access to Finance

20%

Regulatory Uncertainty Macroeconomic Instability Cost of Financing

% of firms saying issue is serious problem

Figure 58: In the 2002 BEEPS Survey, firms were most concerned about regulatory uncertainty, macroeconomic instability and financing

Source: Business Environment and Enterprise Performance Survey.

The results from the 2002 BEEPS survey suggest some interesting comparisons with earlier surveys (see Figure 58). First, as in the other surveys, firms were very concerned about policy instability.

More firms in the 2002 survey rated policy instability as a serious problem than any other area of the investment climate. Second, as in the 2004 Enterprise survey and the 2005 BEEPS survey, there

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was generally little concern about most areas of regulation, infrastructure or access to land. Except for electricity, there was little concern about any of these areas of the investment climate in the 2007 Enterprise Survey either. Third, as in the 2004 Enterprise Survey, firms were very concerned about access to financing and its cost. These concerns were notably lower in the two later surveys.

Fourth, as in the later surveys, tax rates and corruption are a serious concern for many firms.

Although tax rates might appear to be less of a concern for firms in the 2002 survey than they did in the 2005 survey (fifth in 2002 compared to first in 2005), the percentage of firms that said that tax rates were a serious problem was fairly close in the two surveys (33 percent in 2002 compared to 38 percent in 2005). That is, rather than perceptions about tax rates declining significantly between the two survey, it seems that perceptions about other things (e.g., financing and macroeconomic instability) improved significantly meaning that the fall in rankings between the two surveys is due to, at least in part, to the relative improvements in other areas. As in the 2004 and 2007 surveys— although not the 2005 BEEPS survey—crime also ranked a significant concern in the 2002 BEEPS survey. Worker education was less of a concern in 2002 than in 2007, although it was not a significant concern in 2004 or 2005 either.

The 1999 Business Environment and Enterprise Performance Survey (BEEPS) The first BEEPS survey was administered in 1999 as part of the World Business Environment Survey (WBES). The sampling methodology was similar to the methodology described above for the later BEEPS surveys in 2002 and 2005. Quotas were applied—although they were slightly different from the quotas in the later BEEPS surveys—and weights were not calculated. As in the later surveys, responses were given on a four-point scale. The questionnaires were less similar to the 2002 and 2005 surveys. In particular, the list of constraints was quite different. Most notably, the questionnaire asked about ‘infrastructure’ rather than about electricity and transportation separately.

In addition, the questionnaire asked quite detailed questions about various aspects of regulation and access to finance. Since these were not included in later surveys, they are not discussed here.

80% 60% 40%

Labor Regulations

Courts

Customs and Trade Regulation

Source: Business Environment and Enterprise Performance Survey.

Business Licensing

Infrastructure

Corruption

Tax Administration

Crime

Organized Crime

Cost of Financing

Macroeconomic Instability Regulatory Uncertainty

0%

Access to Finance

20%

Tax Rates

% of firms saying issue is serious problem

Figure 59: In the 1999 BEEPS Survey, firms were most concerned about tax rates, access to finance, macroeconomic instability and regulatory uncertainty

The top concern was high tax rates, which about 60 percent of firms rated as a serious obstacle in 1999. This was considerably higher than in 2002 (33 percent of firms said it was a problem, ranking it fifth overall) and 2005 (38 percent of firms ranking it first overall). The next two constraints, macroeconomic instability and access to finance, were also among the top constraints in 2002, although their importance appeared to have fallen by the time of the 2005 (and 2007) surveys.

Finally, as in most of the later surveys, most areas of regulation and infrastructure did not rank as serious constraints. One notable difference is that concern about corruption appeared more modest in the 1999 survey than in later surveys.

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89

The Global Competitiveness Report (2003/04-2007/08) The Global Competitiveness Report of the World Economic Forum collects data on perceived problems in over 100 countries on an annual basis. Most of the questions in the report are qualitative questions about how they would rate the investment climate in their country relative to the investment climate in other countries. Most questions are scored on a 7-point scale. For example, on the question of the brain drain, firm managers are asked whether “Your country’s talented people 1=normally leave to pursue opportunities in other countries; 7=almost always remain in the country.

Similarly, on math and science education, firm managers are asked “Math and Science Education in your country’s schools 1=lag far behind most other countries’ schools, 7=are among the best in the world.

In addition to asking these questions comparing their countries, since the 2003/04 survey, firm managers have been asked to rate the top 5 constraints in their country from a list of 14 possible constraints. Their responses are then combined to rank each of the 14 constraints in each country.

This approach is slightly different from the approach used in the other surveys discussed in this report, where firm surveys were asked to rate each obstacle on a four-or five-point scale and the percent of firms that said it was a ‘major’ or ‘very severe’ obstacle was computed.

Although there is some overlap between the 14 constraints that the Global Competitiveness Report asks about and the constraints that the Enterprise Survey, there are some differences. In particular, although the 14 constraints include several constraints identical or similar to the constraints in the Enterprise Survey (e.g., crime and theft, corruption, inadequately educated workers, and access to financing), it includes several additional obstacles not included in the enterprise survey (e.g., poor work ethic and inefficient bureaucracy), and asks other questions differently (e.g., rather than asking about power and transportation separately, it asks about inadequate infrastructure).

The first difference is that the sample is somewhat different from the samples in the previous surveys. For instance, the sample is smaller than in the Enterprise Survey. Whereas the Enterprise survey (2007) contained about 1000 firms, the samples for the Global Competitiveness Report varied between 85 and 167 firms between 2003/04 and 2007/08.76 A second difference is that the Global Competitiveness Report aims at surveying the most sizeable employers and has a preference for interviewing executive with an “international perspective” (e.g., executives at domestic firms selling in international markets or units of foreign firms operating in the domestic market).77 Not surprisingly, the samples for the Global Competitiveness Report tend to have more large firms than the sample for the Enterprise Survey. For example, medium-sized and large firms with over 100 employees made up 43 percent of the sample in the 2003/04 sample and 25 percent of the sample in the 2007/08 sample compared to about 8 percent of the weighted sample in the Enterprise Survey.

Given the differences in approach and sampling, it is not surprising that the results from the two surveys are not identical. But there are similarities. For example, corruption ranks as the top constraint in the most recent Global Competitiveness Report of the six constraints covered in both surveys (see Table 30). The very top constraint in the Global Competitiveness Report—inefficient government bureaucracy—is not included in the Enterprise Survey. Inadequately educated workers ranks second of the six overlapping constraints in the Enterprise Survey and third in the Global Competitiveness Report. Tax rates and crime rank as third and fourth constraints among the overlapping constraints in the Enterprise Survey and fourth and fifth in the Global Competitiveness Report. Labor regulation ranks fifth of six in the Enterprise Survey and sixth in the Global Competitiveness Report.

Table 30: Ranking of constraints in the Global Competitiveness Report, 2003-2008 (Bulgaria) 2003/04 2004/5 2005/06 2006/07 2007/08 Access to Financing 1 1 2 2 3 Corruption 3 2 3 3 2 Crime and Theft 6 7 8 8 9 Foreign Currency Regulations 14 14 14 14 14 Government Instability/Coups 8 10 10 11 13 Inadequate Infrastructure 9 6 5 5 4 see on next page >>

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2003/04

2004/5

2005/06

2006/07

2007/08

Inadequately Educated Workers

12

11

11

7

5

Inefficient Bureaucracy Inflation Policy Instability Poor Work Ethic Restrictive Labor Regulations Tax Rates Tax Regulation

4 11 7 13 10 5 2

4 13 8 12 9 5 3

1 13 9 12 7 6 4

1 13 12 10 9 6 4

1 12 11 8 10 7 6

Source: Porter and Others (2004; 2005; 2007); Lopez-Claros and Others (2005; 2006).

There are also some similarities with respect to trends. Most notable, concern about access to finance and taxation appears to have declined over time in both the Enterprise Surveys and BEEPS surveys and in the Global Competitiveness Report. Similarly, concern about inadequately educated workers has increased in both sets of surveys and concern about corruption does not appear to have changed significantly over time in either case.

There are, however, some differences. The most notable difference is that access to finance ranks sixth among the six common constraints in the Enterprise Survey but ranks second among the six in the Global Competitiveness Report. Overall, it ranks third in the Global Competitiveness Report, but only 14th in the Enterprise Survey. Thus although the pattern of declining concern over time is similar in the BEEPS/Enterprise Surveys and the Global Competitiveness Report, the decline is far more notable in the BEEPS and Enterprise Surveys.

There are also some differences in responses between the two surveys where the constraints are phrased or grouped differently in the two surveys. For example, inadequate supply of infrastructure ranks as a serious problem in the Global Competitiveness Report, but neither component (power or transportation) ranks among the top constraints in the Enterprise Survey. Similarly, the broader area of tax regulation ranks as a serious problem in the Global Competitiveness Report, whereas the similar—but much narrower—area of tax administration ranks far lower in the Enterprise Survey.

Finally, whereas instability ranks among the top concerns in the Enterprise Survey, the narrower category in the Global Competitiveness report (Government instability/coups) does not rank as a serious constraint. Given the differences in the way the constraints are phrased, it seems plausible that this might explain the difference between the two questions. For example, firms might be concerned about policy instability in Bulgaria, but they are far less concerned about coups or political violence, leading to a significant difference in responses when the constraint explicitly refers to coups.

V. Summary This chapter discusses the areas of the investment climate that firm managers say are the biggest problems that they face. One notable result is that firms appear to be concerned about various areas of the investment climate related to regulation. Although firms did not say that most of the individual areas of regulation that the survey asked about were serious problems (labor regulation, trade regulations and business licensing), there was concern about both corruption and informality—two common symptoms of over-regulation. In addition, there appears to be concern about the stability of regulatory policy. Firms ranked instability as second biggest constraint for their activity in the 2007 Enterprise Survey. There is an important distinction, however, between political instability, which usually refers to coups and revolutions, and policy instability, which seems to be a more likely explanation for this result. In fact, on other parts of the survey, firms reported that they were concerned about the level and predictability of regulation. These issues are discussed in greater detail in Chapter 6.

Worker education and skills are a growing concern—especially for innovative firms and firms in the IT sector. Given the link between innovation, productivity and wages (see Chapter 2), this is likely to be an especially significant problem for firms trying to move into high value-added activities in the same sector or move from labor-intensive to capital-intensive sectors of the economy, which yield higher value added.

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Concern about infrastructure was relatively modest—consistent with results from Chapter 2 that suggest that inadequate infrastructure does not have a large impact on firm-level productivity.

However, it is also important to note that concern about infrastructure appears greater in 2007 than it did in earlier surveys. Although electricity supply only ranked as the eighth most significant obstacle in the 2007 Enterprise Survey, this is worse than its relative ranking in earlier surveys.

Some other concerns are far more muted than in previous surveys. In particular, managers— including managers of small firms—were far less likely to see access to finance as a significant constraint in 2007 than they were in earlier surveys. Indeed, access to finance no longer ranks among the top constraints in Bulgaria. In general, concern about tax rates also appears lower— although concern has not declined as rapidly as concern about some other areas of the investment climate (e.g., access to finance).

Chapter 6: Regulation and Taxation Sound regulation and a strong tax system are vital components of any modern economy. Sound regulation corrects market failures that inhibit productive investment and reconciles the interests of firms with the interests of society. Strong tax systems are needed to finance public services that are needed to invest in a strong investment climate and public welfare (World Bank, 2004b).

Although taxation and regulation are necessary, burdensome regulation and high taxes can inhibit growth, encourage informality and corruption, discourage investment and harm productivity (World Bank, 2004a). Inefficient administrative procedures at the central and municipal levels cost businesses time and money, reducing productivity and investment. Erratic enforcement and unpredictable changes to regulation stop firms from investing in long-term projects, including research and development and human capital improvements. In addition, regulations that make it difficult for firms to enter and exit the market stop inefficient firms from closing, diverting workers and resources, and prevent new and dynamic firms from entering.78 Finally, slow contract enforcement and weak property right protection by the courts cost firms money and can encourage corruption.

Improving regulation obviously benefits private firms, allowing them to become more competitive and to operate more easily. But Government also benefits from improved regulation. Innovative “smart regulation” allows the public sector to become more efficient as it requires less resources and less time to administer.

Regulatory reform is a major priority in Bulgaria. In part, this reflects the high priority that it has achieved in the EU with the work of the Mandelkern group on Better Regulation and the European Commission’s Better Regulation Program (2002). Better Regulation strategies, adopted at different levels in Europe, aim to contribute to growth and create jobs.

As an accession member to the EU, Bulgaria has made progress in the area of regulatory reform by adopting the European legislation through the acquis communautaire. The country made substantial progress in 2003, when it adopted the Limiting Administrative Regulation and Control on Economic Activities (LARACEA) Act79 and when it created the Council for Economic Growth (CEG) one year earlier. The CEG is chaired by the Minister of Economy and Energy and has become an important public-private consultative forum. The CEG promoted the introduction of Regulatory Impact Assessments (RIAs) in Bulgaria.80 Moreover, the Ministry of Economy and Energy (MoEE) has emerged in 2007 as a leader of Regulatory Policy and RIA initiatives by working together with other line ministries, business associations, think tanks and the World Bank.

“Bulgaria’s Policy for Regulatory Reform in the European Union: Converging with Europe’s Best Regulatory Environments”,81 recommended a national nine-step strategy that was approved by the Council for Economic Policy on October 19, 2007.82 This joint document of the MoEE and the World Bank, and the consultation process with other line ministries, business associations and think tanks, paved the way for the “Better Regulation Program 2008-2010”, approved by the Bulgarian Government in April 2008.83 Program implementation was initiated in April 2008 and currently, the Administration of the Council of Ministers (CoM) is responsible for implementation. In June 2008, a Better Regulation Unit was established under the auspices of the CoM to manage, monitor and control the implementation of the program. The program has specific deadlines, responsible institutions and builds upon several measures that are clustered under four strategic areas, namely: •

Removal and Reduction of Administrative Regimes;

•

Establishment of Institutional Structure for Implementation and Control of the Better Regulation Policy; 93

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•

Acceleration of the dialogue with interested parties;

•

Regulatory Improvement at the Municipal level.

As discussed in Chapter 5, tax administration, business licensing and registration were rated as serious problems by less than one-quarter of the firms in the survey. Based upon the percent of firms that said each area was a serious obstacle, this places them 9th and 11th out of the 15 obstacles that all firms on the survey were asked about.84 However, although firms did not have specific complaints about the specific narrow areas of regulation that were asked about on the Enterprise Survey, evidence from the survey suggests that red-tape and burdensome regulation remain an obstacle to firm operations in Bulgaria. First, over 45 percent of firm managers said that corruption and close to 40 percent said that competition with informal firms were serious problems for their firm. Both corruption and informality should be seen as symptoms of other problems in the investment climate and many studies have found that both are linked to burdensome regulations, red-tape and taxation.85 In addition, although the survey did not ask about regulatory uncertainty directly, it has been among the top concerns when it is included (see Chapter 5). Moreover, given Bulgaria’s recent accession to the EU and its low risk for armed conflict or insurrection, the most reasonable explanation for the concern about political instability is that it reflects concern about instability of policy (see Chapter 5). Finally, the burden of red-tape is strongly associated with low firm productivity in Bulgaria (see Chapter 2).

I. Regulation Senior managers in Bulgaria spend 17 percent of their time dealing with requirements imposed by government regulations (taxes, customs, labor regulations, licensing and registration) for the average firm in the Enterprise survey. This is high compared to other countries. In the 2007 Enterprise survey for Croatia, the average firm reported that senior management spends about 11 percent of their time dealing with requirements due to government regulations, whereas in Moldova, which is heavily criticized for overregulation and administrative barriers, firm managers spend about the same time in dealing with regulations as in Bulgaria.

100% 75% 50%

Poland

Czech Republic

Latvia

Lithuania

Romania

Hungary

Slovenia

Slovakia

Estonia

0%

Bulgaria 2005

25%

Bulgaria 2007

% of firms that disagree that regulations are interpreted consistently

Figure 60: Firms are concerned about the predictability and consistency of how laws and regulation are interpreted

Source: World Bank Enterprise Surveys.

Note: Data for comparators is from BEEPS survey. Although the question was phrased similarly, the scale was on a four-point scale for the 2007 survey and a six point scale for the 2005 survey. In particular, there were two additional categories (“agree in most cases” and “disagree in most cases”. For the 2005 survey, it is for the percent of firms that either strongly disagreed, disagreed in most cases, or tended to disagree. In the 2007 survey, it is for the percent of firms that either strongly disagreed, or tended to disagree since the middle category is omitted.

Earlier survey suggests that the time spent by senior managers in dealing with regulations has dropped slightly. The Administrative and Regulatory Cost Survey (ARCS) asks a similar question and it showed in 2004 that managers of companies in Bulgaria spent a significant amount of their working time—approximately one-fourth—dealing with administrative matters and requirements (including meetings, paperwork, etc.).

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95

In 2002, they reported spending 23 percent of their working time. Although the percentage of time spent by the senior management in dealing with requirements imposed by government regulations between 2002 and 2007 dropped by 5 percent and 8 percent, respectively, this is still very high.

The relationship between government and business is crucial to doing business. It is important how government officials, both, at the central and at the local level, interpret laws and regulations that affect businesses. In addition to concern about the overall burden of regulation, firms were also concerned about the consistency and predictability of the interpretation of laws and regulations. As discussed in Chapter 5, this seems to reflect a high level of concern about the stability of poicy.

In the 2007 Enterprise Survey, over 70 percent of businesses either strongly disagreed or tended to disagree with the statement that public authorities’ interpretations of laws and regulations are consistent and predictable. This is high compared to firms in other EU entrants, and is higher than in 2005 (see Figure 60). The rapid transposition of the acquis communautaire in the Bulgarian legislation might have given administrative authorities little time to adapt their policies and hence might have led to uneven enforcement.

Barriers to Entry Bulgaria tends to perform relatively poorly compared to other recent EU entrants and best practice countries with respect to the time and cost of registering a business. According to Doing Business 2008, it took 32 days at the beginning of 2007 to incorporate a company in Sofia, compared to 6 in EU Best Practice (Denmark), 7 in Estonia, 14 in Romania, and 15 on average in the OECD countries (see Table 31.)

Table 31: The number of procedures, number of days and cost to start a business Procedures (#) Bulgaria (Sofia) EU Best Practice (Denmark) OECD Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia

Time (days)

Start-up cost (% of income per capita) 2006 2007 7.9 8.4

2006 9

2007 9

2006 32

2007 32

4

4

6

6

0.0

0.0

6.7 10 6 6 5 7 10 5 9 9

6 10 5 6 5 7 10 6 9 9

18.5 24 35 38 16 26 31 11 25 60

14.9 17 7 16 16 26 31 14 25 60

7.6 8.9 5.1 20.9 3.5 2.8 21.4 4.4 4.8 9.4

5.1 10.6 2 17.7 3 3 21.2 4.7 4.2 8.5

Source: World Bank (2007b).

The main reason for the long registration time is that the court registration takes 12 days and public notification in the State Gazette takes 15 days. Estonia, which is a benchmarking country, has substantially improved the time for business registration in the past two years. It takes 7 days to complete registration compared to 35 days one year earlier. This became possible because of the introduction of a new electronic system since January 2007 at the Commercial Registry. It permits registrations to be completed in only one day. In Romania, the registration at the Unique Office of Trade Registry, Bucharest Tribunal, obtain court registration, publication of notice and registration for statistical purposes and social security are considered as one procedure that takes 3 days. In Bulgaria, similar activities are done through five procedures in about 30 days.

The cost of establishing a company in Bulgaria is also higher than in many of the best-performing comparator countries. It costs 8.4 percent of per-capita GNI to start a business in Sofia, compared to 2 percent in Estonia, 3 percent in Latvia and Lithuania and 5 percent in OECD countries. Romania also performs better than Bulgaria in this respect (4.7 percent of per-capita GNI).

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The first registration procedure in Bulgaria is obtaining a certificate for registered name. It is executed in 1 day (15-30 minutes) and the cost is 100 BGN (€50) or 102 BGN (€51) if by phone. In Romania, 50 RON (€14) are paid to the public authorities for that service, whereas in Slovakia it costs 100 SKK (€3), or for free if one checks the Companies Register of the Ministry of Justice. Thus, it is not clear whether in Bulgaria the fees paid by firms reflect only administrative costs or they cross-subsidize other tasks.

Modern registration systems in Europe only require registration at the Trade Registry, which saves time and cost for the business. Electronic registration, which can make it easy to make documents publicly accessible, can further reduce costs. It can also save time when the firm applies for operation licenses, permissions, or other services which require registration documents. Thus, business registration in Bulgaria continues to be complex, slow and expensive vis-à-vis comparator economies, although calls for its improvement were put on the table in 2004.

A World Bank report from 2004 (Djankov, 2004) proposed that the company registration can be simplified and streamlined if the scale and complexity of the documents that were required to establish a new firm were reduced by using standardized forms, whereas a USAID report analyzed several options for change to improve business registration in 2004 (Jacobs, 2004). The USAID report called for speeding up registration processes and reducing uncertainty; complying with EU directives for paperless registration and fees that cover costs, but produce no profits; creating a national electronic registry with standardized procedures nation-wide; freeing up the time of judges for firm registration purposes; and improving public access to the information in the database among others.

Introduction of single identification number, which allows to cut a number of procedures, electronic system of registration, which allows easy access to databases as well as on-line registration, transfer of the registry out of courts and turning a judicial procedure into an administrative one, thus adhering to the best practice in business registration and EU guidelines, was witnessed only in early 2008. Thus, lots of momentum was lost despite the World Bank’s support to the Government through the Programmatic Adjustment Loan (PAL) and USAID support between 2003 and 2005 to improve business registration.

The registry reform was discussed by business associations, think tanks and the government as early as between 2001 and 2003.86 An inter-ministerial expert group, which was created in April 2004, came out with a Strategy for creating a Central Registry of legal persons and establishing an Electronic Registry Center. The strategy was approved by the CoM in April 2005 and the Trade Registry Act was adopted by the National Parliament in April 2006. But, the Trade Registry started operation only on January 1, 2008 after a long discussion about the provisions of the law and secondary legislation.87 The delayed introduction of the Trade Registry caused time and costs for the business in Bulgaria.

Businesses had to register with the Commercial Register at the District Court (27 across the country and the Sofia City Court) and within the municipality (264 in the country). Since these could not be done electronically, the process was more burdensome than in most other countries in Europe, where modern systems for registration were already in place (examples are provided below). In addition, since businesses were not electronically registered before 1 January 2008, public authorities (ministries, public agencies, municipalities, etc.) frequently asked for hard copies of registration documents for any kind of business operation regime (permission, license, etc.).

Despite the delayed adoption of the Trade Registry Act and its enforcement, the needed Agency capacity for the Trade Registry delivery service was not created. The Chief Directorate “Trade Register and BULSTAT Register”, based in Sofia, and its 27 Service Units have had substantial difficulties in administering the system because of understaffing and lack of technical and human capacity. One problem is that the Registry Agency lacks technical and human capacity needed to handle electronic registration and to work with the District Courts across the country. Salaries of the registration officers were about 500 Lev (€250) until the end of March 2008, making hiring difficult.

On the other hand, this is because of the provisions in the law for pre-registration of commercial entities. The business has been allowed for three years to pre-register in the new registration system, whereas de facto it has to pre-register in 6 months from the inception of the Trade Registry system

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97

because of the requirement that existing firms are obliged to provide financial reports until June 2008. Another problem is related to the pre-registration of firms that have unique name in the District (as the previous system, required registration at the District Court), whereas at present, firms need to have unique names for the national territory. This causes problems, especially for larger firms, which have already established reputation on the market, issued stocks on the market, etc. Moreover, trade registration through the on-line system is rare since there is little promotion among firms (fee payments for on-line registration should be decreased substantially). Finally, public access to the firm documentation is important for improving business transactions as this raises trust among business partners. However, publication of personal identification documents (name, personal address, and signature) of the owners on the Internet, required by the Trade Registry, may be facilitating crime.

The Limiting Administrative Regulation and Control on Economic Activities Act (LARACEA) was adopted on June 4, 2003. It was intended to reform the regulatory environment by providing incentives for the business in simplifying administrative regimes and administrative control.

However, there have been high levels of non-compliance with the provisions of the Act by central authorities and municipalities. In addition, no amendment was made to secondary legislation leading to the illegal application of the executive power and the local municipalities of regulatory regimes for the business.

According to the law, there are 54 licensing regimes, administered only by the central power, 58 registration regimes, 280 permission regimes and no existing concerted regimes. A recent report by the Bulgarian Industrial Association, however, found that 1935 regulatory regimes are administered, most of them (60 licensing, 368 registration, 747 permission and 69 concerted regimes) illegally by local municipalities (Bulgarian Industrial Association, 2007).88 Number of Regimes in Bulgaria

Figure 61: Administered regulatory regimes in Bulgaria 800

Central Municipal

600 400 200 0

Licensing Registration Permissions Source: Bulgarian Industrial Association (2007).

Concerted

The introduction of the Administrative Register by the Ministry of State Administration and Administrative Reforms, similarly to the Trade Registry, has been postponed several times since May 2007, when this was first announced. This allowed for the operation of illegal practices for administrative or regulatory regimes by central and local authorities, discussed above.

The Administration Act introduced one single model for organization of the administrative structures of the executive authorities and it introduces the creation of an electronic and public Administrative Register, which outlines: i) the administrative structures of the executive power; ii) information about regulatory regimes (licensing, registration and permission regimes). The regulatory regime part of the Register, according to the internet site of the Ministry of State Administration and Administrative Reform (responsible for the creation of the register), shall include: •

Full text of normative acts (law, ordinance, statute, and others), which define the responsibilities of the bodies of executive power in terms of regulatory regimes;

•

Outline of the subject and type of regime;

•

Description of the procedure for issue of individual act for each separate regulatory regime; public authority for the issue of the approval; requirements and documents; administrative service unit, which administers the issue of the act; administrative service unit, which accepts documents and provides information;

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•

Fees for the issue of individual act of regulatory regime;

•

Samples and documents, necessary to fill in so that an individual act is issued for the application of the regulatory regime.

The introduction of the on-line Administrative Register, as announced in May 2008, is planned to start operation in October 2008. Until then, the illegal practice of municipalities in registering businesses in Bulgaria is likely to continue (see Box 10).

Box 10: Administration of registration regime by the Bulgarian Municipality (2007) Municipalities in Bulgaria are autonomous, and each municipality adopts ordinances on registration requirements based on the Local Self-Governance and Local Administration Act, and the Local Tax and Fee Act. The purpose of registrations with the municipality and onsite inspections is to ensure that registering firms meet health, safety, environmental protection and urban planning requirements. The procedures, time and cost of registering vary with the municipality. As an example, registering with the Ihtiman municipality requires submitting an application including nine documents and takes about 14 days. The application fee varies depending on the type of business, ranging from 20 Lev (€10) for retailers in villages to 1,500 Lev (€750) for public catering businesses.

Businesses need to pay these fees both initially, in order to register, and annually, in order to remain in operation. The approval process requires that an expert board verify the documents and conduct an on-site inspection of the firm, which costs 4 Lev (€2). The compliance control is conducted by the control organs of the economic development unit within the municipality, the tax administration and the local police. The value added by the municipality registration is not clear, particularly considering that safety, health and environmental standards are assessed and monitored by specialized central authorities (the Ministry of Health, the Ministry of Environment and Waters and the Ministry of Interior Affairs). Municipalities also lack the capacity to implement administrative procedures, and municipal officials need further training on regulatory functions and procedures.

Source: Reichel, Motta and Evgeniev (2007).

The need for effective electronic operation of the Administrative and the Trade registers and the abolishment of illegal administration practices of regulatory regimes by central, and especially by local authorities in Bulgaria are necessary due to the regulatory burden that they impose on business activities. Furthermore, the Better Regulation Program plans interventions to improve regulation at the municipal level and strengthen regional and municipal capacity for good regulatory practices.

The administration procedure for registration should avoid submission of identical documents by businesses to variety of publi c authorities. The duplication for registration wastes business time and increases registration costs. In order to receive operation licenses, permissions or any other contact with public authorities, businesses in Bulgaria, for instance in the food-processing industry and trade, are required to present hard copies of their registration files to several public authorities, which is costly and time consuming (see Box 11).

Box 11: Food-Processing Registration in Bulgaria (2007) Firms processing and trading food of animal origin need to register with the National Veterinary and Sanitary Service (NVSS) under the Ministry of Agriculture and Food Supply. The Regional Veterinary and Medical Service (RVMS) registers sites used for extraction, production, processing, conservation, packaging and pre-packaging of raw materials and foods of animal origin, as well as wholesalers of food with animal origin and retailers offering only food of animal origin. The law sets a deadline of seven days for registration (Art.137, Veterinary Act). The registration fees are based on the type of processed product according to the tariff system. Before registering with RVMS, retailers offering food of animal origin must register with the Regional Inspection for Prevention and Control of Public Health. This requires 15 days, in addition to the seven days needed to register with RVMS (Foodstuffs Act. Art. 12 (5). NVSS is responsible for inspections of the production and sale of animal products “from the field to the table Inspections are paid for by the inspected business (fees were set in Jan.2007 by the Tariff and Fees Schedule of the NVSS. Source: Reichel, Motta and Evgeniev (2007).

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Policy recommendations Streamline the administrative procedures for registration by avoiding submission of identical documents by businesses to variety of public authorities. The duplication for registration wastes business time and increases registration costs. The administrative procedures to start a business have shortcomings and should be streamlined so that the government can successfully compete as a new entrant to the EU market. The following measures are recommended to improve the national registration system and reduce firm’s entry costs, number of procedures and time to administer.

Prepare a full impact assessment of LARACEA to identify changes that would improve its functioning and its impact. LARACEA was created as a common legal act, which creates a clear model for administrative regulation and control. It was intended to serve as a good basis for the creation of a package of special administrative acts that would affect businesses. Deadlines for issue of registration approval by public authorities or introduction of the principle of “silent consent” should be applied with the registration procedure as the LARACEA prescribes. However, this is rarely the case. Therefore, it is recommendable that the LARACEA is given a full assessment of its implementation to explore the gaps in the law and track the illegal practice by municipalities and central authorities. The Assessment could identify the package of special administrative acts that have to be amended so that the law functions, as its spirit prescribes.

Municipality registration procedure is cumbersome, lengthy and superfluous that needs to be either abolished or replaced by a simple notification obligation. Municipalities are illegally imposing registration that duplicates national registration in order to impose fees, thus support their budgets. However, where registration and permission regimes are applied according to the law, the municipality registration can be transformed into mere notification obligation. The notification procedure can be recommended and usually it contains general business information (owner, address, type of business, occupied space, and number of employees) and pay a small notification fee to the municipality. Information on the obligation to notify should be provided in brochures and on the Internet.

Reduce registration fees and target universal reduction of the administrative cost for businesses. The administrative costs to register start-ups do not justify the high registration fees for the business. The LARACEA prescribes that the regulation has its sense if the costs for its application (compliance, administration and control) are less than the benefits from its introduction and administration. Thus, costs upon businesses should be regarded, as well as the possibilities for the exercise of effective administrative control and the costs linked to its application. The overall start-up cost in Bulgaria is 8.4 percent оf income per capita and it should reach at least the cost in the neighboring countries (e.g. Romania stands at 4.7 percent). Therefore, it is recommendable that a special methodology for the classification of the tariffs for the central administrative service fees is developed. A strategic policy document that will embrace the administration practice and provide an instrument for classification of the tariffs for the central administration service fees could target universal reduction of the administrative cost for businesses in Bulgaria.

Reduce the steps and the time to complete the registration procedures through the effective use of the Trade Registry. Although the single ID for firms was introduced in 2008, a lot of problematic areas are associated with the introduction of the Trade Registry since 1 January 2008, which is not functioning well. The Trade Registry and the single ID for firms may be extensively used to streamline registration procedures. A review of the procedures and their streamlining based on the new realities is required. Requirements for pre-registration at the Trade Registry should be discussed with the business until an effective strategy is devised.

Channel additional resources to the Trade Registry to improve its functioning. Capacity building of the Trade Registry and adequate staffing are crucial elements for the institutional set-up of the national registration system. Additional resources could be channeled to improve capacity building of the Trade Registry so it improves its functioning in serving the business.

Monitor registration practices at the municipal and central levels. Review of administration procedures and improving coordination among public authorities in order to avoid duplication of submission of identical documents, duplication of regimes at the central and at the local level, and extra pay for the same procedure would be made possible through the effective functioning of the Administrative Register. An on-line monitoring system shall be a supportive tool to avoid illegal application of the regimes across municipalities and at the central level. The Administrative Register can be helpful in improving access to the information, raising awareness and monitoring

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of implementation. Avoidance of duplication of documentary requirements, electronic document flow/exchange between government agencies should be encouraged (e.g., all documents on business registration can be received from the Trade Registry).

Licensing Although registration and licensing are often used synonymously, they differ in several important ways. A registration regime cannot issue refusals if the business has presented all the necessary documents to satisfy the requirements of the law for starting an operation. In contrast, administrative bodies that issue licenses can refuse to authorize the license for particular business activity based on expedience in conformity and within the framework of the law.

In Bulgaria, the law is explicit. Licenses are issued only by the central administrative organ (LARACEA, Art.8, par.2). This means that the municipalities cannot issue licenses and cannot apply administrative regulation which is decided on the basis of expedience. The Municipality ordinances that, for instance, treat “registration of trade objects�, are a typical example of licenses and the law prescribes that the regime, in this case, should be transformed into registration and/or notification regime. The license is issued without terms (if the law has not prescribed something else) and the rights for the license are not subject to transfer or remission. Obtaining a license is a condition for the business to start operation of the business activity, based on expedience. The licensing administrative body has to create and maintain public register, which has to publish all entities that have licenses, or have received suspension of their licenses, license termination or have been deprived of their license.

Bulgaria has worsened its position compared to other countries in the world with respect to dealing with licenses. The Doing Business report (World Bank, 2007b), which looks at the specific example of the licenses and procedures that must be completed by a business to build a standardized warehouse indicated that Bulgaria ranks at 103rd position in terms of dealing with licenses.89 In comparison, it ranked 85th in the previous year. Licensing and permits in the construction industry are discussed in more detail in the next section on access to land.

Firms in the Enterprise Survey are asked how much of an obstacle licensing and registration procedures are to firm operations in Bulgaria. Overall, firm managers were not overly concerned about licensing. Only about 20 percent said that it was a serious problem, ranking at the 11th largest constraint out of 15. It is important to note, however, that this might underestimate the true burden.

Since the firms in the Enterprise Survey have been operating for several years at least in most cases, licensing and registration are probably a smaller concern for these firms than for new firms trying to enter the market.

Firms in the Enterprise Survey that received an operating license within the past two years were asked how long the process took. Over 90 percent of firms had to wait more than 7 days for an operating license from the central authorities. About one-third said that they had to wait over 30 days. The average wait was 48 days for an operating license, while the median weight was 30 days.

Bribes were relatively uncommon, with only about 2 percent of firms saying that a bribe was required or requested.

Firms were also asked about import licenses in the Enterprise Survey. Waits for import licenses were shorter than for operating licenses. About one-quarter of firms waited 7 days or more for an import license. About 6 percent waited 30 days or longer for the license. On average, they waited 5 days for an import license. Less than 2 percent of firms reported that bribes were requested or required.

The low number of enterprises reporting that bribe payments were needed to licenses suggests that bribes might have fallen in recent years. The 2005 BEEPS survey did not ask any direct questions on bribe payment, it did ask whether bribes were needed to deal with various transactions never, seldom, sometimes, frequently, usually or always. At this time, about one-half of firm managers said that bribes were never needed when obtaining business licenses and another 24 percent said they were seldom needed. About 2 percent said they were always needed and another 5 percent said they were usually needed.90

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Procedures to obtain operating licenses differ significantly between and within sectors. One reason for this is that different public authorities are in charge of different sectors and so requirements and different criteria apply. For instance, firms in the food sector in the Enterprise Survey respond that they needed over 30 days on average to complete licensing and registration procedures compared to only 18 days in the garment sector.91 Even within sectors, firms apply to different agencies and ministries in order to start and operate business (see Table 32).

Table 32: Registration and Licensing in the food processing and trade sector in Bulgaria

---

Ministry of Agriculture and Food Issues import licenses for agriculture products

Processed products of plant origin

Registration of food processing companies

Issues import licenses for agriculture products

Export of processed foodstuffs

Registration of trading company

Sale of foodstuffs (supermarkets, restaurants)

Registration of establishment

Product, activity

Ministry of Health

Processed products of animal origin

National Veterinary and Sanitary Service Registration of food processing company; veterinary medical certificate for export; veterinary controls

State Agricultural Fund

---

--Export license

---

Registration of food processing trading company; veterinary medical certificate for export; veterinary controls

---

---

---

---

Source: Reichel, Motta and Evgeniev (2007).

Firms processing and trading food have to register and get licenses from different authorities— the Municipality, the Ministry of Health and the Ministry of Agriculture and Food Supply, and this is cumbersome. The public authorities that register and grant permissions and approve licenses require identical documents, which results in duplications and wasted time and cost for the firms. The split of responsibility and control between the Ministry of Health and the Ministry of Agriculture and Food Supply is sub-optimal. Both Ministries are in charge of food safety. The Ministry of Health is responsible for the safety of food of non-animal origin, and the Ministry of Agriculture and Food Supply is responsible for the safety of food of animal origin. This division, although it has been there for long time, appears arbitrary. Food processors and traders often deal with both kinds of products and are inspected by and subject to the food safety measures of both ministries. Redundant work, lack of information exchange and coordination problems between the two ministries negatively impact firms that have to deal with either or both of them.

The creation of a single authority responsible for the implementation of food safety regulations was announced in mid-2007, but as of June 2008, it still does not function. Leaving responsibility for policy-making to the Food Safety Authority would eliminate procedural overlaps between the Ministry of Health, the Ministry of Agriculture and Food Supply and the other public agencies involved in registering, licensing and granting permissions for food firms and for firms that trade with food.

Firms in the hotel and restaurant business have to obtain classification (operating license). The tourism business is a fast growing and dynamic industry in Bulgaria. Hotels and restaurants reply to high quality international standards and they should comply with rules, prescribed in the secondary legislation, regarding the classification system (1-5 star system applied). In order to register and obtain classification for a hotel, there is a need to submit 6 documents to the State Tourism Agency (STA). These documents are available on-line on the Internet site of the STA, but it is not identified how much time the procedure takes and in addition, it is impossible for the business to register for classification electronically. The main secondary legislation is the ordinance for classification

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of hotel accommodations, lodgings, restaurants and bars. Within 14 days of submission of the application, but before registration, the STA issues a so-called temporary document that allows the applicant to start operation. Within 30 days, the establishment should receive the classification, granted either by Expert Commission within STA (for higher star establishments) or by Expert commission, appointed by the mayor of the municipality where the establishment is situated (for lower star establishments). In June 2007, the ordinance for classification of hotels, lodgings, restaurants and bars has been substantially improved so that it responds to international quality standards.92 The temporary document, which is valid for two months, confirms that the submitted application is formally complete. The final registration is issued after an on-site inspection and a decision by the committee established in the STA or the committee, established at the municipality.

The tourism business associations take part in these commissions. The first registration is valid indefinitely, and inspections are not conducted during the period of validity. According to STA officials, the registration procedure for classification takes between one and three months. However, business associations reported in 2007 that the classification procedure may take up to 12 months.

Classification fees depend on the size of the categorized establishment, varying between US$340 and US$3,420 for hotels and between US$74 and US$950 for restaurants.

Businesses handling food for consumption, such as restaurants, need to register with the STA, the Municipality and with the Regional Inspection for Preservation and Control of Public Health (RIPCPH). In addition to registering with the Commercial Registry at the District Court, the municipality and the STA, restaurants, bars and other businesses handling food for consumption need to register with RIPCPH, which is responsible for implementing and organizing the State health policy on the territory of the respective region. The RIPCPH maintains a public registry of registered businesses.

Licensing in some sectors has improved with the adoption of uniform rules, practiced in the Community Market. In the Road Transportation Sector, Bulgaria adopted the rules that apply in the Community Market. For international cargo and passenger transportation, Bulgarian transport firms need to obtain a Community license in order to operate. They need to provide 10 documents, wait for 30 days and pay 2,060 Lev (€1,030). This is clearly and well defined on the Internet site of the Automobile Administration Executive Agency. No on-site inspection for the business is prescribed in order to obtain the license. The registration of each cargo or passenger vehicle costs 400 Lev per year (€200). In addition, the Executive Agency issues certificates and keeps a register of vehicles attached to each license for the conduct of transport of passengers and cargo on the territory of Bulgaria. Once a vehicle is recorded in the database of the Ministry of Transport, it can be transferred to another license. The international bus license is valid for five years and can be renewed. The Executive Agency inspects at least once during the five-year period to ensure requirements and standards are met. For cargo transportation outside Bulgaria, the firm needs a license very similar to the one for international passenger transport. The cargo license has the same requirements as the passenger license. In addition, companies transporting goods for third parties—whether within or outside of Bulgaria—need a special license.

The procedures to get permission for international transit, however, is inefficient (Reichel and others, 2007). Firms transporting goods to third countries have to obtain a separate permission for every truckload. The procedure to receive the permission is time-consuming and redundant. There is an electronic system in place at the Executive Agency. However, according to transport businesses, this system often fails to register the most efficient route for the transportation. As a consequence, if the transport firm wants to take the most efficient route, then the manager has to physically visit the Agency, based in Sofia, and apply for another transit permission. Such manual applications are not registered in the electronic system, and the permissions must be picked up individually.

Policy recommendations Bulgaria can improve its standing in respect to Dealing with Licensing, targeting EU best practice.

The following policy changes are recommended to improve the regime.

Streamline the procedure to obtain import licensing and especially operating licenses for businesses. Fewer steps can be used to obtain licenses, duplication of documents, already submitted should be avoided and businesses have to have access to sectoral electronic public registry, which can publish the licensees, the validity of the licenses, and the terminated licensees. In this respect, the good functioning of the Administrative Register can serve the purpose.

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Focus the licensing reform on Small-and-Medium-sized Enterprises. The Ministry of Economy and Energy has to specifically consider the barriers for SMEs in the application process for licenses. The objective would be to draw particular attention to administrative barriers for small firms and simplify the application procedure for licenses.

Streamline licensing procedures for food producers and traders of food of animal and nonanimal origin through the establishment of a Food Safety Authority. This requires reviewing existing procedures and improving coordination among the municipality, the Ministry of Health and the Ministry of Agriculture and Food in order to avoid requiring firms to submit the same documents to different institutions. The Food Safety Authority needs to start operation as soon as possible so that it replaces the old system of licensing and inspection in the food-processing and food trade industry and close the circle from the “field to the table”.

Apply post-inspections instead of renewal of licenses. Some licenses are issued for five years or some for indefinite period, and post-licensing inspections are missing. Risk-based inspections at the municipality level could result in more efficient inspections, instead of central authorities (see the section on inspections).

Review of licensing in specific dynamically developing sectors could be initiated and if possible outsourced to business associations. Licensing in the transport industry has been relaxed due to Bulgaria’s entry to the EU. The licensing procedure in the tourism sector, however, which is applied through the classification system, should be reformed. The classification system can be abolished and licensing can be transformed into simple registration. The authority which registers hotels can be outsourced to the tourism business associations, whereas the inspection service can be performed by the local municipalities instead of the State Tourism Agency that can focus more on tourism strategies, marketing of destinations and tourism policy. The information on sector licenses in the Enterprise Survey are not sufficient to make particular recommendations for other sectors, but a licensing reform, involving business associations as partners to the government, can target dynamically developing sectors in order to reduce administrative barriers for operating businesses.

Inspections and Certification Businesses in Bulgaria have many interactions with the public administration. For example, to get a construction permit an on-site inspection is done by the Water and Sanitation authorities, Fire Department, Electricity Distribution Authorities and the telecommunication company. To be classified for the tourism industry, the enterprise needs an on-site inspection to verify whether the hotel accommodation fulfills the criteria for the classification type it applies. Value Added Tax (VAT) returns for businesses require that tax inspector visits the business premises and prepares a report.

As noted previously, the average firm manager in the Enterprise Survey for Bulgaria estimates that about 17 percent of the senior management’s time is spent on dealing with requirements imposed by business regulations. Some of this time is spent with the inspectors, which visit the premises.

The Enterprise Survey also asks firms specifically about tax inspections. Most of the enterprises in the Enterprise Survey (70 percent) reported that they have been visited and or inspected by tax authorities. Four times per year, on average, are the businesses inspected by tax officials, which is high.

Other inspections are also necessary for most firms. During field interviews in 2008, it was suggested that market inspections for canned vegetable and fruit producers, selling on the domestic market are insufficient and this results in the supply of products that do not meet quality standards.

Reichel, Motta and Evgeniev (2007) found that some of these firms continued to sell on the domestic market to large retailers even after Bulgaria’s entry to the EU. High flat fee for food inspections and laboratory fees are present in Bulgaria. Food-processing and trading firms have to pay high flat fees to laboratories examining food products. In addition, the fees are not linked to the size of the inspected lots, which results particularly in high costs for small-and-medium-sized enterprises.

Creating a single authority responsible for the implementation of food safety regulations and food policy, would eliminate problems of food policy coordination, procedural overlaps and

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uncoordinated inspection schedules between the Ministry of Health and the Ministry of Agriculture and Food and the National Council for Food Safety. The responsibilities of the National Food Agency would include development of food policy, provision of technical assistance, acquisition and review of food safety related information, labeling and packaging, and monitoring and inspection of food related activities. It is important that such a body has some independence and that policy functions be separated from inspection and control functions.

Inspections in the tourism sector are slow. The classification category is issued after an on-site inspection and a decision by a committee established in the STA with private sector participation or by a local expert committee at the Municipality. The first registration is valid indefinitely, and inspections are not conducted during the period of validity. After issuing the classification for a tourist site and registering the tour operator or tourist agency’s activity, however, the STA does not carry out any follow up. Although the STA has a mandate to conduct inspections, it has neither the human resources nor the financial resources to do so.

Most countries conduct regular inspections of tourism facilities. The inspection periods vary from one to three years. In addition to the regular inspections, there are sometimes “mystery inspections” without previous notice. Table 7 below describes the inspection practices of a few selected countries.

Table 33: Inspection of Hotels, Guesthouses, hostels, etc., regarding standards, by country Periodicity of Inspectors Inspection regime inspections Announced visit at fixed Austria Hotel industry inspectors Every three years date Central government Not regularly, acting Bulgaria -/inspectors only on complaints Czech Announced visit at fixed Hotel industry inspectors Every two years Republic date Announced visit at fixed Denmark Hotel industry inspectors Every year date and mystery checks France Hotel industry inspectors Mystery checks occasionally Announced visit at fixed Germany Hotel industry inspectors Every three years date Central local government Announced visit at fixed Romania Every three years and hotel industry inspectors date and mystery checks Government and hotel Announced visit at fixed Turkey Occasionally industry inspectors date and mystery checks Source: Reichel, Motta and Evgeniev (2007).

Obtaining voluntary health and environment certification, particularly in industries, like construction, food, textiles and garments, hotel and restaurants, and machinery is an important indicator for the competitiveness of firms in the international business environment. Minority of the Bulgarian firms in these sectors, however, have obtained the certification that would guarantee that the product/service processing has been done according to international standards and that the end customer would get the product expected that meets high quality standards.

Table 34: Percent of firms, who submitted application for certification over the last two years Industry Construction Food Textile Hotel and Restaurants Machinery Garments

Health certificate

Environmental certificate

18 % 49 % 7% 36 % 2% 8%

0% 9% 0% 0% 4% 7%

Source: World Bank Enterprise Survey (2007).

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It takes a relatively long time to get a health certificate in Bulgaria. The average waiting period for firms to obtain health certificate is 20 days. Moreover, 20 percent of firms have reported that they waited for 30 days to obtain this certification.

Policy recommendations Increase capacity building for the public and municipal authorities that implement regulatory regimes. Training for public and municipal authorities and technical capacity building on how to apply and maintain effectively regulatory regimes, the execution of procedures and inspection regimes could improve consistency and predictability of the regulatory environment.

Increase self-regulation for the tourism activities. A system of risk-based inspections following issuance of the classification of tourism facilities should be introduced by inspection authorities.

Self-regulation of the tourism sector can be encouraged by transferring the mandate from STA to business associations of conducting evaluation for the classification rating and development of quality standards. The registration of the tourism activities can be improved with the good functioning of the Trade Registry and the improvement of the implementation of LARACEA. The STA can focus its activities more on strategies for development of the tourism industry, marketing and promotion of the national tourism product.

Evaluate the efficiency of inspections and consider centralizing the inspection authority for foodstuffs. More work is needed to assess the efficiency of the current inspection service in the food sector. The analysis may include an assessment of whether a common inspection service for all food- and feed-related inspections could be created. In this respect, the speed up of the creation of Food Safety Authority and centralization of the inspection and control regime in the food industry is a good way to reform.

Introduce risk-based inspections in the food sector. Routine inspections are not very effective, therefore randomly risk-based inspections can predominate. However, they need to be linked to a provision of sanctions for violations that are enforceable and that carry additional inspections in the future.

Base inspection fees for laboratory testing in the food sector on the size of the establishment.

The Government could consider introducing a schedule with three categories based on the size of the inspected lot.

Provide incentives for Bulgarian enterprises that obtain voluntary certificates for the conduct of their business operation. The government can provide incentives to enterprises, who have obtained necessary voluntary certification for the conduct of their business operation.

Exit Business exit from the market is often considered a barrier to firm entry since the cumbersome bankruptcy procedures keep inefficient firms operating longer than necessary and prevent more productive entities enter the market. Previous studies have found that exit is burdensome for firms in Bulgaria. Recent reforms, however, have substantially improved bankruptcy and insolvency procedures and this should have an impact in the near future.

The Doing Business report (World Bank, 2007b) presents detailed information on the steps required to go through bankruptcy procedures as of the beginning of 2007. The procedures are for a representative standardized business for a firm that has had to default on its loans and needs to go through the judicial system to resolve its bankruptcy (i.e., no informal out-of-court workouts).

The procedures are relatively time consuming in Bulgaria. The estimated time required to resolve a bankruptcy for this representative firm was 3.3 years on average. This is about three times as long as in the best practice country in the EU (0.9 years) and it over twice as long as the average for the OECD (1.6 years). It is also somewhere near the middle for other recent EU entrants (see Table 35).

The cost of the proceedings is about 9 percent of the estate. This is fairly close to the average for the OECD (7.5 percent), about twice the level of the best practice country in the EU (Finland, 4 percent), and better than or comparable to most of the other recent EU entrants.

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The long time that bankruptcy proceedings take means that the assets depreciate considerably.

As discussed below, however, changes in the Commercial Act have improved the situation recently.

The recovery rate, expressed in how many cents on the dollar claimants recover from the insolvent firm is also shown (see Table 35). As of the beginning of 2007, the Doing business data show that the recovery rate of 32.4 percent was among the lowest in the comparator economies. It is also much lower than OECD average (74.1 percent) and EU best practice (Finland, 88.2 percent).

Slow preparation for formal bankruptcy processes, and a lack of strong incentives for the trustees (bankruptcy administrators) to recover as much as possible quickly, may be among the reasons.

Table 35: Time and cost of closing a business, selected countries Country/rank

Bulgaria (Sofia)

Time (years)

Cost (% of estate)

Recovery rate (Cents on the USD)

2006

2007

2006

2007

2006

2007

3.3

3.3

9

9

34

32.4

EU Best Practice 0.9 0.9 4 4 89 88.2 (Finland) OECD --1.3 --7.5 --74.1 Czech Republic 9.2 6.5 15 15 18 21.3 Estonia 3 3 9 9 40 39.1 Hungary 2 2 15 15 40 38.4 Latvia 3 3 13 13 35 34.6 Lithuania 1.7 1.7 7 7 51 49.2 Poland 3 3 22 22 28 27.8 Romania 4.6 3.3 9 9 20 28.9 Slovakia 4 4 18 18 48 45.2 Slovenia 2 2 8 8 45 46.6 Source: Doing Business report (World Bank 2007, 2008).

Note: The representative company has 201 employees, one main secured creditor and 50 unsecured creditors.

Power has shifted to creditors in bankruptcy cases and insolvency procedures. The Bulgarian Commercial Act gives the chance to the creditor to file a bankruptcy petition. The Act stipulates, according to Art.625 (added SG.70, 1998, amended SG.84, 2000, amended and added SG.58, 2003, added SG.38, 2006), the insolvency procedure can be initiated through a written petition, submitted by the debtor, respectively by the liquidator or by the creditor of the debtor as per commercial deed, or by the State Receivables Collection Agency if state private claims are due. Moreover, the assembly of creditors plays a substantial role in the insolvency procedure. According to Art.677, par.1.1 (amend. SG.58, 2003) from the Act, the assembly of creditors defines the order for payment of the debtor to its creditors, the method and conditions for assessment of the property, the selection of evaluators and the identification of their remuneration. Furthermore, the bankruptcy trustee is released by the court if non-compliance with his obligations are observable, but also because of decision of the Assembly of Creditors (Commercial Act, Art.657, par.1.5) or can be also released by the creditors, holding more than half of the claims (Commercial Act, Art.657, par.1.4).

Substantial changes have been introduced to speed up the process of bankruptcy and insolvency procedure. The debtor, which is insolvent or over indebted, has to initiate a procedure for insolvency within 30 days (Commercial Act, as amend. in 2006, Art.626, par.1). Then, the procurator has to inform in written form the commercial firm for its insolvency within 7 days. The court has to invite, in closed doors, the debtor and the creditor within 14 days from the moment the request letter was officially submitted (Commercial Act, Art.629, par.2). In addition, the court, when detecting insolvency, defines a date of the first assembly of the creditors not later than one month from the court decision (Commercial Act, Art.630, par.5).

Another positive development is that according to the recent amendment of the Commercial Act (SG.38/2006), the rehabilitation plan can be proposed at most one month after the court has defined the list of the accepted claims in the Trade Registry (Art.698, par.1). Moreover, one or more rehabilitation plans can be proposed (Art.698, par.2).

Court proceedings have also been simplified. Bankruptcy cases are heard by the District Court and the Appeal court, rather than in three instances as it used to be.

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Analysis of the documentation of the process to investigate, list and verify the debtor’s assets would help the proper introduction of new changes in the law. Based on the positive changes in the legal system, it is expected that court proceedings for firms that want to exit would speed up, cost for the exit would decrease and recovery rates would increase in Bulgaria. However, more analysis, based on recent changes in the legal system, and the application of the law in practice can contribute to achieving the effectiveness of the system.

The remuneration for the bankruptcy trustee might be linked to the proceeds realized from cashed assets. The court appoints the trustee, who is a physical person, if he/she responds to a number of criteria (Commercial Act, Art. 655, par.2). One of these criteria holds that the trustee has to pass a special qualification exam and be appointed by the Minister of Justice. There are two types of remunerations paid to the trustee - current and final. The range of both remunerations is defined by the assembly of creditors (Art.661, par.1). The current remuneration is paid on a monthly basis and the final remuneration can be paid after a rehabilitation plan is approved (par.4) or as a percentage of the asset value with which the insolvency mass has been fulfilled (par.5), and/or as a percentage of the value of the cashed assets. In order to speed up the bankruptcy procedure and create incentives for the trustee to manage that well, it is necessary to link the trustee remuneration to the proceeds realized from cashed assets.

The State Receivables Collection Agency was established in 1999 and it is an Agency of the Ministry of Finance, having six regional structures. It secures collateral and enforces the collection of public receivables. It participates in bankruptcy trials where the state is a creditor for public receivables. According to the Law, the Agency must accept, keep and sell all possessions and goods seized on behalf of the state. For its purposes, it has constructed an internet portal, which provides information about evaluators (address, telephone), auctions (date, registry, information about the auction, type of action). This example can be followed through establishing internet portals by District Courts to announce decisions and announcement of asset sales in cases when the state is not involved as a creditor for public receivables.

Policy recommendations Recent reforms in the bankruptcy and liquidation procedures have introduced changes that may speed up the time for exit of firms from the market, thus giving a chance for competitive firms to operate in a better business environment. Some recommendations are proposed to improve the exit of firms.

Introduce a monitoring system to track the duration of trials and judgments for enforcing contracts. Changes in the law related to documentation of the process to investigate, list and verify the debtor’s assets would improve timing for the exit of firms. Once the process of documentation for investigation, listing and verification of debtor’s assets is speeded up, timing for court proceedings would decrease, as well as the costs for exit (very high, as reported in Table 3.10). Further analysis would be needed to support the new changes in the Commercial Act.

The remuneration for the bankruptcy trustee has to be linked to the proceeds realized from cashed assets. Linking trustee’s remuneration to the proceeds realized from cashed assets would increase trustee’s performance in bankruptcy procedures.

Use the internet to post District court decisions and publicize auctions. Establishing internet portals by District Courts, similar to the one that is maintained by the State Receivables Collection Agency to post court decisions and announce asset sales in cases when the state is not involved as a creditor for public receivables.

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II. Access to Land Land and Buildings account for a significant part of a country’s wealth. Once firms register their land or buildings, they can obtain mortgage and expand their businesses. However, access to land and buildings, and the price that firms have to pay for them depend on the way the construction industry operates. This, in turn, depends upon government regulation such as the number of administrative procedures to transfer land or obtain permission for construction and the time and money it takes to complete them. If the bureaucratic process slows down the procedures, because of inadequate staffing, ineffective public service or corruption, or because fees are too high, this can be a problem for firms trying to start or expand their operations.

Only about 20 percent of firms said access to land was a serious problem and most firms said that it was no obstacle. The Enterprise Survey shows that half of the firms owned all of the land occupied by the establishment about 40 percent leased it all. The remaining firms owned some, but not all, of the land the establishment occupies. Firms that owned their land were less likely to say that land was a serious problem (about 16 percent of firms) than firms that leased the land their establishment used (about 31 percent of firms).93 As discussed in Chapter 5, larger firms and firms in the IT sector tend to be less concerned about access to land than other firms are.

Only about 15 percent of the firms in the Enterprise Survey reported that they had applied for a construction-related permit within the past two years. Very few of these—about 7 percent—said that an informal gift and no payment was expected or requested. Moreover, the procedure seems to be slower in Bulgaria that in other countries in the region. The average time to obtain a construction permit was 136 days in Bulgaria compared to 128 days for firms elsewhere in Europe and Central Asia.

Boom of the construction sector The construction industry has become increasingly important in Bulgaria in recent years, reflecting the tremendous growth of FDI in the Real Estate, Renting and Business Activities (see Chapter 1).

The private construction sector accounts for about 20 percent of the industrial gross value added and employs around 134,000 people or 9 percent of total employees with labor contracts.94 As such, it is one of the largest employers in the country.

FDI inflows into the construction sector have grown substantially. In 1998, they represented only 0.5 percent of FDI inflows. By 2007, they accounted for 12 percent of inflows.95 FDI inflows in the Real Estate, Renting and Business Activities have grown even more spectacularly. In 2006 and 2007, they represented 28 percent (€1.7 b.) and 36 percent (€2.2 b.) of total FDI.96 Although construction activity has increased supply, a boom in demand for residential buildings and office spaces has increased prices. The average price per square meter for a residential building in Sofia has increased to 1,650 Lev/m2 in 2007. In comparison it was 1,340 Lev/m2 in 2006 and 1,220 Lev/m2 in 2005. The rent per square meter for an office in Sofia is higher than in Bratislava or Budapest and it has reached the level of other capitals in the region (see Table 36).

Table 36: Rents in Sofia are as high as in other capitals in the region Market Average Prime rent (EUR/m2/ Cap. rate/ Initial yield, % month) Athens 15-23 7.5 Belgrade 18-22 9.0 Bratislava 14-18 6.0 Bucharest 17-20 7.0 Budapest 14-17 5.25 Prague 19-20 5.5 Sofia 15-22 7.2-9.0

Source: Address Real Estate Agency, Foros Real Estate Agency, Imoti.net, obtained from www.investbg.government.bg.

Industrial space is less expensive in Bulgaria than in many other countries in the region, although rents are increasing.97 The average rent per square meter for industrial space is between 2 and 4 EUR/m² in the Varna, Plovdiv, and Bourgas industrial zones and between 2 and 6 EUR/m² in the Sofia industrial zones.98

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The Encouragement of Investment Law (prom. SG.97/24, Oct.1997, last amended in May 2007) provides an infrastructure subsidy for the construction of physical infrastructure to foreign investors that are awarded Class A certificates for investments of at least 70 million Lev (€35 million) or for implementation of two or more certified investment projects within the territory of an industrial zone.99 The investor submits a written request to the Ministry of Economy and Energy and presents an approved design (conceptual, schematic or working) with a fully itemized cost estimate for the construction of the elements of the physical infrastructure, which may serve for issuing of a building permit and for award of a construction contract under the Public Procurement Act. Then, the Minister of Economy and Energy presents the Council of Ministers with a motion for promotion of the investment projects observing the ranking order. The Council of Ministers adopts a decree on allocation of resources under the project for construction of physical-infrastructure elements and authorizes the Minister of Economy and Energy to conclude the requisite contracts.

Land Administration System The Law on Spatial Planning (LSP) was adopted in 2001 and was amended between April 2001 and July 2007.100 Currently, many rules and procedures follow best practice.101 The LSP governs the entire sphere of rules related to issuing construction permits and also governs issues related to urban planning and development. However, implementation has been difficult due to the LSP’s complexity and inflexibility and because it does not create incentives for local municipalities to effectively function in pursuing the objectives of the law. A Regulatory Impact Assessment (RIA) was recently conducted by the Institute for Market Economics (IME) on the issuance of construction permits in Bulgaria. The report estimated that proposed reforms (e.g. introduction of e-government, optimization of the Detailed Development Plans, one-stop shops, saved time for court proceedings) would have net benefits of around 111 million Lev (€55.5 million). Public discussion of necessary reforms in the LSP can lead to the adoption of amendments and secondary legislation that improve the law and its application (see 3.52).

After January 1, 2008, the Ministry of Regional Development and Public Works (MRDPW) became responsible for the financing, development and adoption of urban plans for the Black Sea Coast. Previously, these had been the responsibility of municipalities. Construction practices which are not relevant to the Law on Spatial Planning (LSP) have taken place in the past few years, leading to over-construction in tourism sites along the Black Sea coast. Proper development of urban planning by the MRDPW (i.e. preparation of “best practice” technical designs, market-based fees for consultants, etc.) is needed to comply with the long-term strategy for tourism sustainability, preservation of the ecological balance and limiting the negative impact of mass tourism.

The procedure for creation of Detailed Development Plans (DDPs), outlined in the LSP, is time consuming and could be streamlined. Before the construction firm applies for the designing visa from the chief architect of the municipality, which is considered first procedure in the application process for construction permit, the site for which the business intends to invest requires a DDP. Therefore, it is needed to start the process of construction permit procedures. The DDP contains plans for vertical planning, the communication-transportation network, water supply, sewerage, electricity supply, geologic research, gas supply, heat supply, and telecommunications. These are approved simultaneously with the DDP and are inseparable from it (Art.108, par.2, LSP). Firms in the construction business complain that creation of the DDPs, which falls in the ambit of the local municipality, is time consuming. Since most DDPs are seriously outdated, it can take between 6 months and 2 years to approve a new DDP. The LSP does not prescribe a time limit for the creation of a new DDP. Businesses suggested that this problem in the results of inadequate staffing in the municipalities.102 A similar problem was identified in a recent Foreign Investment Advisory Service (FIAS) report (Butler, 2006). Since the problems are mainly in the large urban areas, the report proposes that the infrastructure planning component of the DDP should be eliminated since infrastructure is mostly in place and plans can be based on large areas, defined not by parcel boundaries but by landmarks and street networks. The MRDPW has the capacity to regulate the DDPs, thus it is recommended that they develop a simpler design.

The unified Cadastre and Title registration information system is maintained by the Cadastre Agency and the Registry Agency. A USD 30 million. World Bank Project started in 2001. One of the components intended to cover with cadastre maps 3 million. properties in the most active

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land market areas of the country. This target was surpassed ahead of deadlines. Under the second component dealing with property registration, the turnaround time for registration of transactions (sale/purchase/mortgage) was reduced to one day (for properties without incumbrances). The unified IT system (currently under development) will ensure further the transparency and security of data, and efficient customer services.

The lack of the so called specialized maps (beyond the scope of the World Bank Project, and showing the underlying infrastructure), developed on request of the investors according to the Law on Cadastre and Property Register, is slowing down the preparation of the DDPs. Simplification and improvement of the cadastre map production is highly recommendable to ensure the quick coverage of the whole country.

Construction Permits Licenses to construct new buildings The Doing Business report collects comparable cross-country data on the time and cost of having a standardized construction firm build a standardized warehouse. The number of procedures to do this in Bulgaria is high, although the time it takes to complete them is not excessively long. There are 22 procedures needed to get a construction permit according to the Doing Business report. This is high compared to the country in the EU with the fewest procedures (Denmark with 6 procedures), the OECD average (14), Slovakia (13), Slovenia (15), and Romania (17). But, the time needed to apply the procedures in Bulgaria is better than the average for the OECD (see Table 37).

Table 37: Comparison of number of procedures and number of days to deal with licenses in the construction sector in selected economies Procedures (#)

Time (days)

Licensing cost (% of income per capita)

2006

2007

2006

2007

2006

2007

Bulgaria (Sofia)

20

22

127

131

421

499.9

EU Best Practice (Denmark)

6

6

69

69

67.8

61.8

OECD

---

14

---

153.3

---

62.2

36

36

230

180

19.5

18.5

13

13

117

117

34.3

28.1

31

31

217

211

12.4

10.4

26

26

188

188

36.3

27.5

17

17

148

156

140.5

133.1

30

30

308

308

166.1

159.8

17

17

243

243

131.1

124.3

13

13

287

287

17.1

14.9

208

139.8

113.9

Czech Republic Estonia

Hungary Latvia

Lithuania Poland

Romania Slovakia

Slovenia 15 15 208 Source: Doing Business report (World Bank 2007, 2008).

The cost of obtaining all licenses needed to build the warehouse is high by international standards (499.9 percent of per capita income). This is the highest among the new EU-10 member states and is also much higher than the OECD average. One possible reason for this is that the recent construction boom has increased the incentives for public authorities to substantially increase the price of construction permits.

The number of issued construction permits has increased. According to the NSI, the total number of issued construction permits had reached 8,386 in 2002, 12,886 in 2004, 16,865 in 2006 and had increased further, to 18,224, by 2007. The total number of construction permits for residential buildings has also grown from 2,910 in 2002 to 5,780 in 2004, and 10,800 in 2007.

Including the time to issue a DDP, which is needed to start the procedures for issuing construction permits, the time to get a construction permit remains high. Further, the issue of visa from the chief

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architect of the municipality takes about 30 days. Preliminary contracts with the water authorities and approval from the electricity provider, which can be done simultaneously, can take up about 30 days.

The monetary cost is also high. The municipalities have been able to set their own fees and taxes since 2007. To increase municipal budgets, they have substantially increased the cost of construction permits. In Sofia, the Local Municipality Council voted on February 5, 2008 to increase fees for construction permits by at least 50 percent across the board with even greater increases in some areas. In downtown Sofia, businesses will have to pay 21 Lev (€10.5) per square meter, an increase from 14 Lev (€7). Justifications are often linked to municipal investment in local infrastructure.

There are currently no assessments of how these increases have affected investor’s decisions and the growth of price and rents of residential and office buildings in Bulgaria.

Despite the growth in construction permits, high levels of red tape contribute to long time delays and high costs when obtaining construction permits. The recent FIAS report (Butler, 2006) reviewed the procedures for issuing construction permits, showing long delays and high costs in 2005. The report concluded that the problem did not lie in the administrative procedures as prescribed by the law. The Spatial Planning Act transposed European legislation, with many rules and procedures considered “best practice”, into the Bulgarian legislative system. Based on interviews with the private sector, the report concluded, however, that there are serious problems related to ancillary issues, including incomplete cadastre, problems with developing new infrastructure, public officials’ attitudes concerning the private sector, inadequate and inexperienced staffing, and a slow transition to EU construction material standards. Further, the report pointed out that there is no comprehensive guide on the steps to be taken related to administrative procedures for issuing construction permits. Finally, the report suggested that although the law is comprehensive, permits just limited derogations from the standards by local authorities, and creates national standards across the market, some problems remain. In particular, the report contends that the law can be inflexible when measures have to be changed and that the complexity of the law and the absence of detailed normative acts lead to variety of interpretations when the law is imposed.

One year later, another report (Institute for Market Economics, 2007) concluded: “The process for issuance of construction permits in Bulgaria is complex, bureaucratic and originates corruption practices”. This report analyzed procedures for issuing construction permits and found several major problems. These included: (i) lack of information on the required documentation; (ii) a complex law that can lead to corruption; (iii) non-compliance of local administration and public authorities (e.g.

Water and Sanitation, Fire Safety Department, Electricity Distribution and Telecommunications) with the terms prescribed by law for issuing approvals; (iv) the inability of the administration to deal with the complex law; (v) the absence of cadastral map and public register; (vi) the absence of a onestop shop; (vii) the lack of an integrated system for all public authorities that take part in the process; and (viii) missing e-government procedures in the local municipalities. The IME report suggested several measures for simplifying procedures and improving transparency through the adoption of the OPEN System Seoul, which is considered “best practice”. This system allows the business or citizen to follow the whole process on-line.

The IME report’s recommendations, which are similar to the FIAS recommendations from a year earlier, include recommendations that the content of the detailed development plan (LSP, Art.103, par.3) should be simplified; the IT capabilities of local offices of municipalities improved; and that independent consultants should be used to prepare technical assessments and certifications of investment design plans. The IME report also recommends, as does the FIAS report, that expert council to the local municipalities, which approve the issuance of construction permit, should be eliminated and this function outsourced to independent private consultants. They argue that this would speed up procedures, increase transparency and support market competition.

Another problem is that construction companies and investors often do not have a clear idea of the number of procedures, the time necessary to complete the procedures, and the cost of construction permits. The IME report (2007) reviewed the provision of such information for 22 municipalities. It concluded that most municipalities provide some, but not all, information on administrative services related to issuing construction permits on-line. For instance, the report claims that it is possible to request a construction permit on-line in less than half of the municipalities. In addition, most municipalities do not provide information on who is responsible at each stage of the application. It

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recommends, therefore, that there should be standards related to how local municipalities handle construction permits and that they should provide this information more transparently over the Internet. This would allow businesses to follow the steps of the procedure and the terms for implementation by local authorities more easily. Sanctions for non-compliance should be imposed on municipality personnel.

The FIAS report (2006) and the IME report (2007) both emphasize that the municipal agencies need to be better staffed and that local municipality personnel need to be better trained in handling procedures for issuing construction permits. Field interviews with businesses confirm that this is still an issue. One large construction company owner said that “complaining that construction is booming is not a proper excuse by the municipal authorities for not handling the issue appropriately”.

Policy recommendations Promote linking of local SMEs to large foreign companies in industrial zones. Although prices are increasing, industrial space is currently cheaper to rent in Bulgaria than in other economies in the region. Promoting industrial zones where FDI is linked to local SMEs could be an important milestone in industrial policy.

Amend the Law for Spatial Planning to allow for better application of its principles. In particular, the law could be improved with respect to how it deals with Detailed Development Plans.

They could have a simpler design so construction permits could be issued more quickly.

Improve urban planning of the Black Sea coast. Urban planning of the Black Sea coast is currently in the hands of the Ministry of Regional Development and Public Works. Before this it was delegated to municipal authorities. Proper development of urban planning by the MRDPW (i.e. preparation of “best practice” technical designs, market-based fees for consultants, etc.) needs to comply with the long-term strategy for tourism sustainability, preservation of the ecological balance and limiting the negative impact of mass tourism in Bulgaria.

Streamline the issuance of construction permits and provide a limit on their cost. In 2007 and 2008, Municipal Councils have increased the time and cost associated with getting construction permits. The Expert Councils for the issuing permits could be outsourced to private business, which should improve service. The preparation of in-depth studies on problems with issuance of permission for exploitation of the buildings, however, seems necessary. This has not been the target of this report, but there have been indications that this can be problematic for both businesses and households.

Monitor procedures for issuing construction permits. Municipalities in Bulgaria could improve access to information on procedures by publishing them on their websites. The Sofia Municipality could be a benchmarking case. An online system that tracks each step in the application process would also be beneficial.

Improve staffing and efficiency of municipality administrations that issue construction permits. The boom in construction means that more municipal administrators are needed. A system that tracks the performance of each administrator (time to administer number of applications) could improve the efficiency of the process.

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III. Courts and Crime If firms and entrepreneurs are going to invest in medium-or long-term plans, they need to be sure that their investment will be protected. In this respect, a well functioning judicial system is import.

Although courts and crime did not feature among the top concerns of firm managers, more than one in four said that they were serious obstacles.

The high level of concern is consistent with other evidence. A recent World Bank study finds that the Rule of Law, which measures the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, the police, and the courts, as well as the likelihood of crime and violence, is weaker in Bulgaria than in the other new EU entrants (see Figure 62).104 Bulgaria and Romania both rank about at the fiftieth percentile, while the other countries generally rank between the 60th and 80th percentiles. Moreover, Bulgaria’s ranking has not improved significantly—it has consistently ranked around the fiftieth percentile since 1996.

100

80 60 40 20

Source: Kaufmann and others (2007).

Estonia

Slovenia

Hungary

Czech Republic

Latvia

Lithuania

Poland

Romania

0

Bulgaria

Percentile rank on 'rule of law' index (high values mean better rule of law)

Figure 62: Bulgaria compares unfavorably with the other new EU entrants with respect to the Rule of Law

Courts Having a fast and efficient court system is very important. Unless businesses are sure that their property rights will be enforced quickly and cheaply, they will not be willing to enter into arms-length relationships with new customers and suppliers. Moreover, it will also affect how willing suppliers and customers are to extend trade credit to new customers and how willing financial intermediaries are to lend for long-term investment.

The majority of firm managers find that the court system is not fair, impartial and uncorrupted (see Figure 63). Only about 22 percent of firm managers either strongly agreed or tended to agree with the statement that ‘the court system is fair, impartial and uncorrupted”.

Figure 63: Few firm managers in Bulgaria believe that the court system in fair, impartial and uncorrupted

Strongly agree 7% Tend to agree 15%

Stongly disagree 43%

Tend to disagree 35% Source: World Bank Enterprise Survey (2007).

The 2005 BEEPS survey asked a similar question to firm managers—whether they agree that the court system was honest and uncorrupted with respect to resolving business disputes. Only about 30 percent of firm managers in Bulgaria said that this was frequently, usually, or always true

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(see Figure 64). Although cross-country comparisons of perception based questions must always be treated very carefully (see discussion in Chapter 5), this is far lower than in the best performing countries (e.g., Germany) and is somewhere near the middle of sample of countries from the Europe and Central Asia region.

Other evidence from the 2005 BEEPS survey suggests that firm managers were also concerned about other aspects of the judicial system. Only about 47 percent of managers in Bulgaria said that the court system could frequently, usually or always enforce its judgments, only about 42 percent said that it was affordable, 23 percent said it was fair and impartial and 8 percent that it was quick.

Since the Enterprise Survey did not ask similar questions, it is not possible to assess whether views have improved since 2005.

Figure 64: In 2005, Bulgaria ranked towards the middle of the new EU entrants with respect to views about whether the court system was honest and uncorrupted

Country

Germany Greece Ireland Estonia Spain Turkey Slovenia Hungary Belarus Romania Latvia Armenia Portugal Azerbaidjan Tajikistan Georgia Bulgaria Poland Croatia Kazakhstan Slovak Republic Czech Republic Lithuania Uzbekistan Serbia & Montenegro Russian Federation Albania FYR Macedonia Ukraine Bosnia & Herzegovina Kyrgyz Republic Moldova

Transition countries Comparator countries 0

25

50

75

100

Percent of firms saying courts are honest and uncorrupted Source: Anderson and Gray (2007).

In addition to the perception-based information from the Enterprise Survey and the 2005 BEEPS survey, the Doing Business report (World Bank, 2007b) collects information on the cost of using the court system to enforce a simple commercial sales dispute.105 Bulgaria compares relatively unfavorably with other countries based upon this indicator. It ranks 90th out of 178 countries in the world and ranks 24th in the Europe and Central Asia (ECA) region. According to the Doing Business report (2007), the trial and judgment stage in Bulgaria take 334 days, the filling and service takes 105 days, and the enforcement take 125 days—a total of 564 days. In Latvia, ranked first in the ECA region, the trial and judgments procedures takes 110 days and the total time is 279 days, whereas in Hungary, ranked second in the ECA region, it takes 185 days for the trial and judgment phase and 335 days in total.

The average enforcement cost is also relatively high— about 22 percent of the claim. In Latvia and Hungary, the cost is 13 percent of the claim. The enforcement cost in Bulgaria particularly

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high—8 percent of the claim in Bulgaria, compared to 0 percent in Latvia, 1 percent in Romania and 2 percent in Hungary.

Some improvements in speeding up contract enforcement have taken place however since the 2008 Doing Business Report was completed. The recently completed Judicial Public Expenditure and Institutional Review (World Bank, 2008b) argued “weak enforcement of decisions has undermined confidence in the judiciary for years in Bulgaria, but recent innovations to the enforcement regime have begun to yield results.” The report discusses the introduction of private enforcement agents alongside public bailiffs in late 2006, which was the reform assessed by the Doing Business report (World Bank 2007) as one of the ten most successful reforms in the world. The time to enforce a judgment was shortened from 150 days to 125 days between 2006 and 2007, according to the Doing Business report.

The Judicial Public Expenditure and Institutional Review (JPEIR) found that by the end of 2006, 168 private bailiffs were working in all but two judicial regions. They took on 37,280 cases, executed 5,500 cases and collected 90 million Lev (€45 million). As a result, the JPEIR concluded that the system’s rapid development led to a considerable increase in the number of judicial decisions that were executed in 2007. Data from the Ministry of Justice, as reported by JPEIR, show that 168 private bailiffs (compared to 250 state bailiffs) handled 2.25 times more cases, and their collection rate per case was about eighty percent higher than the state bailiffs. The JPIER notes that the public and businesses’ high level of satisfaction concerning the performance of private bailiffs from has led to higher demand for their services. It also notes that there are fewer complaints about their services than about the services of the state bailiffs. Moreover, the new Code of Civil Procedure allows the private bailiffs to serve documents. This should also speed up the judicial process. Monitoring of the system is necessary, however, to track the results from this reform.

Bulgaria recently introduced random allocation of court cases to judges and doubled judges’ salaries. Staff salaries have been the fastest growing component of judicial expenditures—capital expenditures and operation and maintenance costs have increased more slowly. The JPEIR (World Bank, 2008b) emphasizes that this could become an issue. The report also expresses concern about the appointment decisions in regional and district courts. The correlation between new positions created and caseload across the entire population of these courts was only 0.35 in a survey conducted between 2005 and 2006. This indicates that caseload was not the only, or even most important, factor driving the creation of new positions.

Crime The cost of crime and security is high in Bulgaria. About three-quarters of the firms in the Enterprise Survey paid for security (e.g. equipment, personnel, and professional security services).

This is slightly higher than in the 2005 BEEPS survey, where about 68 percent of the firms reported the same. On average, the 2007 Enterprise Survey reported that firms pay 1 percent of total annual sales for security whereas in BEEPS (2005) firms reported that they paid 0.8 percent of total annual sales on average. Most firms in the Enterprise Survey (81 percent) reported they did not experience losses as a result of theft, robbery, vandalism or arson in fiscal year 2006. Those, that experienced losses from theft, reported that an average loss of 1.3 percent of their total annual sales.

Policy recommendations Bulgaria needs to improve its system of law and order to create better investment climate conditions. Possible ways of doing this include the following recommendations.

Introduce a monitoring system to track the duration of trials and judgments for enforcing contracts. The monitoring system will help the government track the effect of the introduced reforms to improve court proceedings and will suggest ways to improve enforcement.

Reduce the enforcement cost and time. The enforcement cost is high compared to the comparator countries and could be reduced. In addition to reducing the costs for firms in disputes, this might also reduce the number of disputes. Firms will be less likely to breach contracts when enforcement is quicker and easier.

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Reduce the high cost that crime imposes upon businesses. Law and order is a public good and reducing the cost of street crime would increase companies’ incentives to invest. A more secure environment would reduce the crime costs for the business and allow them to channel funds to capacity building.

IV. Taxation Tax reform was one of the main reasons why Bulgaria placed among the Top 10 reformers in the most recent Doing Business Report (World Bank, 2007b). The corporate income tax was cut from 15 percent to 10 percent in 2007 and a flat rate of 10 percent was adopted for the personal income tax in 2008. Another positive development was the integration of collection and enforcement functions of tax administration and the social security collection into a new agency, the National Revenue Agency (NRA).

The World Bank-supported Revenue Administration Reform project is in its fifth year of implementation with one more year before closing. By the mid-term review, conducted in mid2006, the project development objectives had been largely achieved. The main results were: •

Tax and social contribution revenues increased as a percent of GDP by 3.6 percentage points between 2002 and 2006, despite reduced tax and social contribution rates.

•

VAT compliance increased by 14 percentage points between 2002 and 2006, exceeding the target agreed at the start of the project. Corporate income tax compliance increased by 7 percentage points over the same period, while payroll tax compliance increased by 2 percentage points.

•

Tax administration has become more efficient, with the ratio of revenue to staff more than doubling between 2002 and 2006. By 2006, the cost of revenue collection was halved, reaching 0.8 percent of revenues in 2006, lower than in most OECD countries. The field office network was streamlined from over 416 offices (including remote offices) to 29 offices.

•

Online filing has been expanded and improvements in the information system have reduced the cost of compliance. Between 2005 and 2006, the share of tax declarations submitted over the Internet quadrupled and the share of personal income tax and social contributions tripled. The provision of third-party information on business registration reduced visits to revenue administration by 600,000 per year.

•

A strong monitoring and evaluation capacity has been developed within the NRA which allowed tracking progress in reform implementation and improving the transparency and accountability of the agency.

Tax Rates

The success of the reform is reflected in the 2007 survey. Firms were generally less likely to say that tax rates were a serious problem in 2007 than they were in earlier surveys (see Chapter 5). Moreover, tax rates no longer rank among the firms’ very top concerns. About 28 percent of firms said that tax rates were a serious problem, the 5th largest constraint based upon the percent of firms that said they were a serious problem. Although the fact that tax rates remain as the fifth greatest concern suggests further improvements might be possible, it is important to emphasize that perceptions about the investment climate in Bulgaria have improved in other areas as well (e.g., access to finance). This means that improvements in perceptions are not as strongly reflected in the relative rankings (i.e., where tax rates ranks compared to other obstacles) than it does in absolute rankings (i.e., the number of firms that say tax rates are a serious problem). In addition, tax rates are typically among the top concerns of firms throughout the world, even when they are low. In recent Enterprise Surveys, tax rates ranked among the top three obstacles in over 50 percent of countries where Enterprise Surveys have been completed and in the top five for four out of five countries (World Bank, 2004b). In this respect, the level of concern appears relatively muted in the 2007 survey.

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As noted above, tax rates have fallen in recent years. The Doing Business report (World Bank, 2007b) calculates the total tax rate for a representative firm in each country. This is the amount of corporate taxes and other taxes that this representative firm would pay after accounting for various deductions and exemptions. Between 2005 and 2007, the Bulgarian government reduced the total tax rate from 42.5 percent to 36.7 percent. This is the second lowest tax rate among the new entrants to the European Union. It is lower than the average for the OECD, and it is only about eight percentage points higher than the country in the EU with the lowest total tax rate (Ireland).

Table 38: Comparison of taxation indicators in selected economies Rank

Bulgaria EU best practice (Ireland) OECD Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia

Payments (#)

Time (hours)

Profit tax (%)

Labor tax (%)

Other taxes (%)

Total tax rate (%)

6

9

76

14.2

12.1

2.6

28.9

---

15

183

20

22.8

3.4

46.2

113

12

930

5.9

39.5

3.2

48.6

31 127 20 71 125 134 122 63

10 24 7 24 41 96 31 22

81 340 219 166 418 202 344 260

9.3 7.9 2.2 8.3 12.7 10.9 9 14.3

38.3 39.4 27.2 35.2 23.6 33.9 39.7 22

1.6 7.9 3.3 4.9 2.1 2.1 1.8 2.9

49.2 55.1 32.6 48.3 38.4 46.9 50.5 39.2

88

Source: World Bank (2007b).

17

616

6.6

26.6

3.5

36.7

Although corporate taxes compare very favorably with other countries, labor taxes compare somewhat less favorably. Despite being lower than in most of the other new entrants to the EU, labor taxes and social security taxes are higher than in the best practice EU countries (e.g., Ireland) and are slightly higher than the average for the OECD (Table 38). Moreover, social contributions are high taking into account the standard of living in Bulgaria. This can lead to businesses evading these taxes. In the Enterprise Survey about 17 percent of firm managers that were willing to answer the question said that they believe that a typical firm in the establishment’s line of business report less than their total workforce for tax purposes. In practice, this is likely to underestimate actual levels of evasion because managers will be reluctant to answer truthfully if they are evading taxes.

The relatively high non-response rate to this question suggests that this might be the case—about 13 percent of managers either refused to answer or said that they did not know.

One common approach used to evade social security contributions, described during field interviews with business consultants, is for businesses to report a lower salary for a worker than the actual salary that they pay. For example, if the minimum social security contribution threshold for an employee in a certain profession is 400 Lev, the employer and employee sign a labor contract for 400 Lev. The firm, however, actually pays the employee 1000 Lev with the other 600 Lev being paid informally. This keeps both firm and employee happy, but results in lost revenue for the Government. Reducing social security contributions would give firms an incentive to reduce this type of informal payment.

The cut in tax rates does not appear to have had a negative impact on revenues. Although the corporate tax was reduced from 15 percent to 10 percent in 2007, reported revenues increased by about 10 percent in 2007. Similarly, forecasts suggest a similar increase in state revenues from personal income taxes after the introduction of the flat tax rate of 10 percent since January 2008.

Tax Administration Even fewer managers in Bulgaria said that tax administration was a serious problem in the Enterprise Survey—only about 23 percent. This makes tax administration only the 9th most serious constraint based upon the percent of firms that said that it was a serious problem. Things are similar looking at the percent of firm managers that said tax rates and administration were the biggest problem that they faced. Only about 2 percent of firm managers said that tax administration was the

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biggest problem that they faced. In contrast to concerns about tax rates, however, concern about tax administration appears to have increased modestly in recent years.

The number of tax payments, which takes into account the method of payment or withholding, the frequency of payment or withholding and the number of agencies involved for the standard case, has decreased from 31 (2006) to 17 (2007). This makes it close to the OECD average (15) and better than in most of the new entrants to the EU (see Table 38).

Despite improvement in the area of the number of tax payments, the time needed to complete all tax forms is both high by international standards and has not fallen over the past three years.

According to data from the Doing Business report (World Bank, 2007b), it took the representative firms 616 hours in order to complete all necessary documentation related to tax payments (see Table 38). Based on this criterion, Bulgaria ranks 160th out of 176 countries in the World, close to Argentina (615 hours), Republic of Congo (606 hours) and Ecuador (600 hours). This is far higher than the best practice EU country (Ireland at 76 hours), higher than the average for the OECD (183 hours) and higher than in all but one of the new EU entrants.

The main bottlenecks appear to be related to VAT payment and Social Security Contributions (288 hours for each) Compared to benchmarking countries, this is very high. For example, Estonian firms need 81 hours to fulfill 10 tax payment procedures. They need additional 27 hours to fill in the online application for the VAT and 34 hours to fill in the social security contributions. Similarly, Slovenia has 22 tax payments, compared to Bulgaria’s 17. But the firms manage to do them in 260 hours compared to 616 hours in Bulgaria. This suggests that introducing an on-line tax payment system— which was noted in the Doing Business Report—is not enough to improve tax administration, unless promotion of electronic payments becomes a strategy for the government (e.g. organizing local campaigns, free distribution of materials and incentives for on-line payments).

The Enterprise Survey also includes some additional information on tax administration. In addition to being asking about whether they see tax rates and tax administration as serious problems, firms are also asked about the frequency of tax inspections. About 63 percent of the business establishments have been visited by tax officials in 2006, according to the Enterprise Survey. About half of those have been visited either once or twice. Large firms have over three times as many inspections as small firms do (see Figure 50). Even after controlling for firm size, exporters and foreign-owned firms also have more (see Appendix 5.1 for econometric analysis). Finally, tax inspections appear to affect perceptions about tax administration—firms that are inspected more are more likely to say that tax administration is a serious problem than other firms are. This suggests that reducing the number of inspection should improve firms’ perceptions about tax administration.

5 4 3 2

Tax admin not serious problem

Foreign

Domestic

Tax Admin is serious problem

Source: World Bank Enterprise Survey (2007).

Non-Exporter

Exporter

Large

Medium

0

Small

1 Micro

% of inspections

Figure 65: Large firms, exporters, and foreign-owned firms face more tax inspections than other firms do

About 2 percent of firms that were inspected said that bribes were either requested or expected during these meetings. This suggests that bribes are not common. Not surprisingly, however, firms that reported that bribes were requested or expected were particularly likely to say that tax administration was a serious problem—nearly half of the small number of firms that reported bribes were requested or expected said that tax administration was a serious concern.

Chapter 6: Regulation and Taxation

119

Interviews with business and experts suggested several additional concerns. First, complex EU legislation has been introduced quickly and this has lowered the capacity of tax administration. In addition, although tax administration has been reformed and tax payment improved through the introduction of online systems, inadequately educated personnel at the tax administration, nontransparent work, a lack of terms for inspections and less monitoring and control continue to be barriers for local businesses.

Another concern is that the permission regime for avoidance of double taxation is not functioning well. Bulgaria is one of the few countries in Europe that imposes a permission regime for the avoidance of double taxation. If the tax is over 100,000 Lev, the foreign business submits a request to the tax administration to avoid double taxation. The National Revenue Agency (NRA) can report in 60 days whether it accepts or overrules the request. If the NRA does not report, then the “silent consent” principle is applied. If there is a negative answer, then the business entity can submit another request and wait another 60 days, and afterwards it can settle the issue in court. If the NRA has a positive reply to the business request, however, it can still be overruled by the tax administration when it conducts the inspection.

Private credit institutions’ requirements for tax payment history have increased compliance.

Banks and other credit institutions require private firms to show a history of tax payments as an important criterion for credit approval.

Policy recommendations Further reduce social security contribution payments. Reducing social security contribution payments will be beneficial for the economy as it will reduce the incentives that firms have to engage in informal practices. However, it has to be done in fiscally sustainable manner by addressing the issue of the very high liabilities of the pension system and a declining and aging population.

Reduce the time it takes to file tax payments. The government has introduced online tax payment system for the business to improve access to tax administration, and promoted electronic payments, but the time necessary for tax payments remains high, which may be a result of the reporting requirements of the National Revenue Agency, which need to be reviewed and relieved in order to serve better tax collection purposes.

Closely monitor tax inspectors for incorrect and corrupt practices. Tax inspectors could be further educated to follow clearly defined guidelines and respect a code of conduct. Tax administration could become more transparent by introducing clear guidelines and terms for delivery of public services; establishing monitoring practice and control for the tax inspectors can lift up certain barriers for the business.

Simplify the permission regime by the National Revenue Agency for the avoidance of double taxation. Bulgaria could turn to European practice and simplify the permission regime for double taxation.

Chapter 7: Labor Markets Employment has risen and unemployment has fallen significantly since the beginning of the decade (see Chapter 1). In 2000, about 52 percent of people between the ages of 15 and 64 were employed (see Table 39) and the unemployment rate was about 19 percent. By 2007, the employment rate had risen to about 62 percent and the unemployment rate had fallen to about 7 percent. Most of the increase in employment has come from the drop in unemployment—relatively few inactive people have entered the labor force (i.e., the labor force participation rate has changed only modestly).

I. Employment and Unemployment in Bulgaria Employment by Age As in most countries, employment rates are lower for younger and older workers (see Table 39).

In 2006, about 55 percent of persons aged 55 to 59 and about 44 percent of persons aged 60 to 64 were employed. This is a significant increase from 2000 when only about one third of persons between 55 and 59 and one fifth of persons between 60 and 64 were employed. However, it remains slightly lower than the average for other countries in the EU. Table 39: Employment rates by age group (in percent) 2000 2001 2002 2003 Bulgaria – All (15-64) 51.5 50.7 51.1 53.1 Bulgaria – 15-24 20.5 21.1 20.5 21.3 Bulgaria – 55-59 33.6 35.1 40 43.6 Bulgaria – 60-64 22.1 24 27.7 30.7 EU 27— All (15-64) 62.1 62.5 62.4 62.6 EU 27 – 15-24 37 37.2 36.7 35.9 EU 27 – 55-59 50.3 51.2 52.3 53.6 EU 27 – 60-64 36.8 37.5 38.2 39.9 Source: Eurostat.

2004 55.1 22.3 46.6 33.3 62.7 35.7 53.7 40.4

2005 55.8 21.6 48.9 34.7 63.4 35.9 54.9 42.3

2006 58.6 23.2 54.6 39.6 64.3 36.3 55.9 43.5

2007 61.7 24.5 ----65.4 37.2 -----

The gap for younger workers is far greater. Only about 25 percent of persons in this age group were employed. This was only a modest increase since 2000, when 21 percent were employed.

Unemployment among this group has fallen significantly since 2000. In 2000, about 34 percent of people in this age group in the labor force were unemployed (see Table 40). This had fallen to about 15 percent by 2007. The dramatic fall in unemployment combined with a more modest increase in employment reflects that the activity rate has fallen slightly since 2000. More people are out of the labor force rather than being either employed or not employed but searching for work (i.e., unemployed).

Not surprisingly, most young people that are neither in the labor force nor unemployed are enrolled in education (World Bank, 2008a). However, about one-quarter of 15 to 24 year olds are not in employment, education or training. More than 60 percent of these have either only a basic education (World Bank, 2008a). The challenge for these youths is to encourage them to reenter education or to acquire training so that they can acquire the skills that they need to compete in the economy.

Table 40: Unemployment Rates by Age Groups in Bulgaria 2000 2001 2002 2003 2004 Total 15 – 24 25 and over

Source: Eurostat.

16.4 33.7 14.5

19.5 38.8 17.2

18.1 37 16

13.7 28.2 12.2

12 25.8 10.6

2005 10.1 22.3 8.9

2006 9 19.5 7.9

2007 6.9 15.1 6.1

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Possiblfy partly in response to poor labor market opportunities for young people in the country, many emigrate from Bulgaria either to work or to further their education. In a recent survey, people in Bulgaria were asked about possible plans and attitudes towards emigration. People under 30 had strong positive attitudes towards the emigration and were the most likely to say that they had plans to emigrate. About 50 percent of all potential long-term emigrants and about 60 percent of labor emigrants were between 15 and 29 years old in 2006.106 Table 41: The Distribution of the Emigrants According to their Attitudes and by Age Groups in 2006 Common sample

Total number Total 15 – 17 18 – 24 25 – 29 30 – 34 35 – 39 40 – 44 45 – 49 50 – 54 54 – 60

Long term emigrants People that will change their place of living

Labor emigrants

196 100.0 9 28 12 10 18 13 5 3 2

91 100.0 16 26 18 4 12 11 8 10 13

2500 100.0 5 14 10 9 12 11 11 12 15

Source: Survey on Emigration, organized by the Gallup International.

Employment by Gender As in most countries, employment rates are lower for women than they are for men. About 56 percent of men between 15 and 64 were employed, compared to about 47 percent of women (see Table 42). Although women’s employment rates are lower, they are closer to the rates in the EU27 than those for men are (Table 42). This suggests that employment rates could be increased for men.

Table 42: Employment rates in Bulgaria by sex for the age group 15 - 64 (in percent) 2000

2001

2002

2003

2004

2005

2006

2007

Bulgaria Total Men

51.5 56.1

50.7 53.6

51.1 54.1

53.1 56.7

55.1 58.7

55.8 60

58.6 62.8

61.7 66.0

Women

47.2

47.9

48.2

49.5

51.6

51.7

54.6

57.6

10.6 14.6

11.8 17.2

11.3 16.3

9.5 13.6

7.6 11.4

7.6 10.8

5.7 8.8

3.7 6.5

6.4

6.4

6.3

5.4

3.7

4.3

2.5

0.7

Differences between EU and Bulgaria Total Men Women

Source: Indicators for monitoring the European Guidelines, including indicators for additional employment analysis, 2007 compendium, last update 23.10.2007, p. 2; Eurostat.

Based upon the most recent numbers, the employment rate for women in Bulgaria should reach the average level observed in other EU countries. Plans to increase the pension age for women to 60 by 2009 could contribute to further increases in employment for women.

Employment by Sector Between 2003 and 2007, total employment increased by about 418,000 jobs (see Table 43). The largest increases were in the construction sector (141,000), Wholesale and retail trade and repairs of motor vehicles and household goods (96,000) and manufacturing (90,000). Financial intermediation and real estate, renting, and business activities grew very quickly in relative terms (35 percent and 34 percent over this period) but started from much smaller bases.

Chapter 7: Labor Markets

Table 43: Changes in employment by sector

Total (in thousands) Agriculture Mining and quarrying Manufacturing Electricity, gas and water Construction Wholesale and retail trade Hotels and restaurants Transp., storage and comm.

Financial intermediation Real estate and business activities Public administration Education Health and social work Other services Corr w/ Change in Employment Corr excl. Agriculture

123

Employ. in 2003 (000s)

Employ. in 2007 (000s)

Change in Employ.

20032007

Growth in employ 20032007

% of workers with higher degree

Average Wage in sector (as % of average)

2835 286 41 677 60 152 423 129 215 31 116 230 210 156 107

3253 245 36 767 60 292 519 163 220 44 163 239 218 162 125

418 -40 -6 89 0 141 96 34 5 13 48 9 7 6 18

14% -15% -15% 12% 1% 66% 20% 23% 2% 35% 34% 4% 3% 4% 15%

25 5 12 13 20 10 20 11 23 67 52 43 70 60 28

100 71 171 90 171 84 81 68 128 232 99 148 100 106 80

-0.23

-0.34

-0.42

-0.52

-

Source: National Statistical Institute (NSI). Household labor force survey (HLFS).

Most job creation has been in sectors where relatively few workers have higher degrees (e.g., doctorate, masters, bachelors or specialist) and where wages are low. The correlation between the number of jobs created and the percent of workers with a higher degree is -.23 and the correlation between jobs created and average wage is -0.34. The correlation is even stronger when agriculture, which appears to be going through a structural decline, is excluded (see Table 43). This is consistent with earlier results from Chapter 1 that suggested that a significant share of investment has been in sectors with relatively low wages. Indeed, there is a strong positive correlation between changes in employment and investment at the sectoral level (0.63).

These results emphasize that a significant share of investment and employment creation has been in relatively low-skilled sectors. Given the strong link between labor productivity and wages, this is discouraging in that it will take sustained increases in productivity to raise wages and living standards.

So an important question is why has growth been focused in these sectors? There is no doubt that demand plays a role—the large amount of investment in construction and real estate reflects the high level of demand for these services. But in other sectors, it is possible that supply of available workers might also be important. That is, the growth in low-wage, low-skill sectors reflects that there are many of these workers available.

Employment and Unemployment by education level Employment rates have increased and unemployment has fallen across almost all levels of educational attainment since 2003. Unemployment rates have fallen from about 6.7 percent in 2003 to 2.3 percent in 2007 for people aged 15 to 64 with tertiary education and from 11.9 percent to 6.7 percent for people with upper secondary education. The changes have been less significant for people with only a lower secondary or primary education. Moreover, employment rates have only increased marginally for people with a lower secondary education (from 24.2 percent to 24.8 percent) and have fallen for people with only a primary education (11.8 percent to 10 percent).

Even in 2003, unemployment rates were very low and employment rates were very high for people with tertiary education. The labor market for these people has become even tighter in recent years.

In contrast, unemployment rates were still relatively high and employment rates relatively low for people with a secondary education in 2003. The overall unemployment rate for people with an upper secondary education was 11.9 percent. Within this group, people with secondary general,

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secondary technical and secondary vocational were 11.9, 11.2, and 12.8 percent. In this respect the expansion of employment and investment for sectors that demand employees with secondary education might not be surprising—unemployment was already relatively low and employment relatively high for people with tertiary education.

Table 44: Employment and unemployment by level of education and labor status 2003 2007 Employment Unemployment Employment Unemployment Rate Rate Rate Rate Total 43.9 12.7 49.9 6.6 Higher 68.5 6.7 71.8 2.3 Degrees Bachelor.

71.2 6.6 76.1 2.4 Master. Doctor Degree Specialist 61 6.8 56.2 2.2 Upper secondary 56.5 11.9 63.5 5.7 Secondary ----70.6 5.4 vocational Secondary general 45 11.9 51.8 6.5 Lower secondary 24.2 19.4 24.8 14.1 Primary or lower 11.8 30.4 10 27.6 Source: National Statistical Institute (NSI). Household labor force survey (HLFS).

II. Workers Skills About 13 percent of firms said that inadequately educated workers were the most severe constraint on their firm and about 34 percent of firms said it was a serious constraint. This makes it the third largest constraint by the first measure and the fourth largest by the second measure (see Chapter 5).

Moreover, there was a strong link between worker education and skills and productivity. Firms with a greater share of skilled workers were far more productive than other firms (see Chapter 2).

Concern about worker education can reflect several different issues. One problem can be getting employees with the right level of formal education. The relatively high levels of employment and relatively low levels of unemployment among workers with tertiary education and secondary vocational education suggest that this is likely to be a problem in Bulgaria. But concern about worker education can also reflect concern about the quality of education at any level of educational attainment. That is, employers might feel that the quality of tertiary and secondary education is low making it difficult to train workers in specific tasks or stopping them form performing at the level expected of them. There is some evidence that this is also the case. The OECD’s latest (2006) PISA survey of the knowledge and skills of 15-year-olds ranks Bulgaria 42nd out of 57 countries, which is below its previous ranking and behind Serbia and Chile.107 Perceptions about worker skills Concern about worker education was not limited to a single sector of the economy. Managers of manufacturing and other service firms were more likely to say that it was a serious constraint than all but four areas of the investment climate, while managers of retail trade firms were more likely to rate it as a serious obstacle than all but three areas of the investment climate.

Although this shows that there is broad concern about worker skills, it was a more serious concern for IT firms that for firms in other sectors. Whereas only about 30 to 40 percent of firms in retail trade, manufacturing, and other services said that inadequately educated workers was a serious constraint, close to two-thirds of firms in the IT sector said the same. Moreover, over one-third of IT firms said that it was the biggest constraint they faced.

There were some additional differences. First, as noted in Chapter 5, firms in sub-sectors of manufacturing that are not skills intensive, such as garments, were less likely to say that skills is a problem than managers in sub-sectors that demand better educated workers (e.g., electronics and machinery and equipment). This strongly suggests that the complaints are not so much about basic education—firms that only need unskilled workers are less concerned than firms that demand more highly educated workers. That is, this suggests that the problem is related to the availability of highly skilled workers rather than the quality of less skilled workers.

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125

Firms that are more innovative (e.g., that introduced new products or production processes between 2004 and 2007) were almost three times as likely to be concerned about worker skills and education than less innovative firms that did not do so (45 percent compared to 16 percent). Further, innovative firms were more likely to say that worker education was a serious problem than any other area of the investment climate (see Figure 50). In contrast, it ranked as only the eighth most significant constraint for less innovative firms. As shown in the appendix to this chapter, these differences are large and statistically significant even after controlling for other factors that might affect perceptions.

Given the strong link between productivity and innovation (see Chapter 2), this suggests that workers skills are likely to become a serious constraint to improving productivity in the medium-term.

Firm-level evidence on training

60%

Innovative Less innovative

40%

Customs and Trade Regulation

Labor Regulations

Access to Land

Transportation

Business Licensing

Tax Administration

Access to Finance

Crime

Courts

Electricity

Tax Rates

Corruption

Political Instability

0%

Informal Competitors

20%

Worker education

% of firms saying issue is serious problem

Figure 66: Whereas workers education is the most serious concern of innovative firms, it does not even rank among the top concerns of less innovative firms

Source: World Bank Enterprise Survey (2007).

Note: Innovative firms introduced either new products or processes. Less innovative firms did not. Information for manufacturing firms only.

In addition to asking firms about whether they are concerned about worker skills and education, manufacturing firms are also asked whether they provide training to their workers. About 37 percent of manufacturing firms in Bulgaria reported that they had a formal training program (i.e., beyond on-the-job training) for their workers in 2007 (see Figure 67). Although it is important to keep in mind the small manufacturing samples in the 2005 BEEPS survey, this is lower than most of the comparator countries in 2005.

100%

75% 50%

Slovakia

Estonia

Slovenia

Czech Republic

Latvia

Poland

Lithuania

Hungary

0%

Romania

25% Bulgaria 2007

% of firms providing training

Figure 67: Bulgarian firms were less likely to provide training than firms in most other new EU entrants

Source: World Bank Enterprise Survey.

Note: Only includes manufacturing firms. Data are for 2007 and 2004 for Bulgaria and for 2005 for other countries.

There are also some differences within Bulgaria with respect to providing training to their workers.

A detailed econometric analysis is presented in Appendix 7.2. As in many countries, large firms are more likely to train their workers than smaller firms are (see Figure 68). Only about one in five micro

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BULGARIA: Investment Climate Assessment

firms and about one-third of small firms provided training compared to about half of medium-sized firms and about two-third of large firms.

It is not surprising that few small firms provide training. If there are large fixed costs associated with firm-based training, the per-worker cost of training will be lower for large firms making it cheaper for them to provide training. Fixed costs might be associated with the cost of bringing outside trainers in (i.e., if they can train groups of workers at a time) or to space requirements.

Another possibility is that large firms might become large as a result of training or a common factor such as ‘high quality management’ or access to liquidity which affects both employment growth and the propensity to train.

100%

Bulgaria New EU entrants

75% 50%

Skills are serious problem

Skills are not serious problem

New product/process

No new product/process

Large

Medium

0%

Small

25%

Micro

% of firms provding training

Figure 68: Large firms, more innovative firms and firms that were concerned about skills were more likely to provide training than other firms were

Source: World Bank Enterprise Survey.

Note: Only includes manufacturing firms. Data are for 2007 for Bulgaria and for 2005 for other new EU entrants.

This is consistent with other studies, which have also found that small companies in Bulgaria are modest in their plans to invest in training. According to the national representative Survey on Labor Demand (2007) only about 54 percent of companies with turnover less than 100.000 BGN had any plans to organize training for their employees in 2007.

The correlation between size and the probability that the firm provides training can also be seen in other new EU entrants (see Figure 68). It is interesting to note that even large firms in Bulgaria lag behind large firms in the other new EU entrants. Whereas over three-quarters of large firms in the other New EU entrants provided training to their workers, only about two-thirds of large Bulgarian firms did so.

Firms that have introduced new products and processes are more likely to provide training to their workers compared to those that have not (see Figure 68). This is not surprising given that there is often a learning-by-doing aspect to innovation (Bell and Pavitt, 1992; Desai and Goldberg, 2007). Introducing new products and new processes will often involve introducing new equipment and machinery and that, in turn, will require that workers are trained. It can also require adjusting management, reorganizing product lines and upgrading worker skills (Desai and Goldberg, 2007).

This emphasizes the link between training and innovation. Firms that are more innovative or that receive ISO quality certification will have to train their workers to adapt to the new products and processes. Further firms that are upgrading product lines or production processes probably have greater need for adaptable skilled workers than firms that do not. In this respect, government programs to encourage firms to provide training will probably also encourage firms to upgrade technology, production processes and quality.

Finally, firms that say that worker education is a problem are also more likely to provide training than other firms. Whereas only about 34 percent of firms that said that skills were not problem provided training, about 41 percent of firms that did not, said the same. This suggests that concern about worker education does not prevent firms from investing in training. Although this result makes sense, it is important to note that even among firms that said that skills were a problem fewer firms provided training than in many of the best-performing of the new EU entrants.

Chapter 7: Labor Markets

127

III. Labor regulation In contrast to skills and education of workers, Labor regulation did not generally rank among enterprises’ top concerns in the 2007 Enterprise Survey. Only about 20 percent of firms said that labor regulation was a serious obstacle, making it only the 12th greatest constraint by this measure, and only about 4 percent of firms said that it was the biggest problem that they faced. Further, labor regulation did not rank among the top concerns in the 2002 and 2005 BEEPS surveys either (World Bank, 2007a, figure 4.4).108 The Rigidity of Employment Regulations As discussed in Chapter 5, perceptions are only an imperfect measure of how binding constraints are. Although the Enterprise Survey does not provide much additional information on the impact of labor regulation, the Doing Business Report (World Bank, 2007b) collects detailed cross-country information on how rigid labor regulations are throughout the world. This section looks at the information from the Doing Business Report to compare labor regulation in Bulgaria with regulation in other countries.

Consistent with the survey data, which suggests that most firms do not see labor regulation as a serious problem, the objective data from the Doing Business Report labor regulation appears to be relatively flexible in Bulgaria when compared with other countries in the region with respect to the Doing Business indicators. Out of the 175 countries for which data are collected, Bulgaria ranked 57th. This was two places behind the Czech Republic, the best performing of the new EU entrants, but was above all other comparator countries (Table 45).

Table 45: Rigidity of Employment Indexes in 2007

Bulgaria Czech Rep Slovakia Poland Hungary Latvia Lithuania Romania Estonia Slovenia

Rank

Difficulty of Hiring Index

Rigidity of Hours Index

Difficulty of Firing Index

Rigidity of Employment Index

57 55 75 78 81 96 124 145 156 166

17 33 17 11 0 50 33 78 33 78

60 40 60 60 80 40 80 80 80 60

10 20 30 40 10 40 30 40 60 50

29 31 36 37 30 43 48 66 58 63

Source: World Bank (2007b).

Nonwage labor cost (% of salary)

23 35 35 21 34 24 31 31 33 19

Firing costs (weeks of wages)

9 22 13 13 35 17 30 8 35 40

As well as an overall ranking, the Doing Business indicators provide more specific information on several areas of labor regulation and the cost of hiring and firing workers (see Appendix 7.3 for a more detailed discussion). Bulgaria compares favorably with respect to flexibility with the other new EU entrants on most of the specific areas of the Doing Business Indicator for employing workers.

Overall, Bulgaria ranks as having the most flexible labor regulations of the new EU entrants with respect to the rigidity of employment, the third-lowest non-wage labor costs and the second lowest firing costs.

The rigidity of employment index is disaggregated into three sub-indices, the difficulty of hiring, the difficulty of firing and the rigidity of hours. Bulgaria’s legislation is very flexible with respect to hiring and firing workers (tie third and tie first among the 10 new EU entrants).

Bulgaria’s labor regulation is less flexible with respect to the third sub-index, the rigidity of hours.

Although only two countries among the new EU entrants have more flexible regulation in this respect (the Czech Republic and Latvia), in contrast to the other measures, Bulgaria does not score any better than most other countries in the region (see Table 45). Moreover, all countries perform relatively poorly on this measure. In fact, of the 175 countries in the 2008 Doing Business report, only about 11 countries score lower than Bulgaria (4 of them from among the new EU entrants). Bulgaria could improve on this index by reducing restrictions on night-time work, number of working days and ‘weekly holiday’ work. See Appendix 7.3 and World Bank (2007b) for more details.

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BULGARIA: Investment Climate Assessment

The Doing Business Indicators do not specifically look at restrictions on part-time work. As discussed below, some evidence suggests that restrictions on part-time employment might also affect the rigidity of labor regulation with respect to hours worked. Recent changes in regulation in 2006 made have made it more attractive for people to enter part-time employment. In particular, part-time worker cannot be placed under less favorable conditions because of their part-time status.

In particular, part-time workers should: (i) receive information on all vacancies and open positions that are available in the company; (ii) get access to professional training and (iii) may not be placed under less favorable conditions solely on the grounds of their part-time status. Also part-time jobs should be available at all levels of employment, including for professional and management position.

These amendments, however, have not generally made it more attractive for firms to hire part-time workers.

The individual components and other areas of regulation related to them, but not specifically included in the Doing Business indicators, are discussed in detail in Appendix 7.3. In particular, the appendix discusses each area of the doing business indicators, noting the areas that affect Bulgaria’s score for each and discusses aspects of labor regulation not specifically included in the Doing Business indicators.

Differences in perceptions about labor regulation, by firm type Although labor regulation does not appear to be a major problem overall, it is possible that it is particularly burdensome for some specific types of firms (e.g., firms that require very flexible arrangements with respect to hours workers). Appendix 7.1 extends the econometric analysis in Chapter 5 to look at whether other factors that might affect perceptions about labor regulation.

40% 30% 20%

Some parttime/temporary

All full-time, permenant

Low Skilled

High Skilled

Shrinking

0%

Slow Growing

10%

Fast Growing

% of firms saying labor regulation is serious problem

Figure 69: Managers of faster growing firms and firms that hire unskilled and part-time workers were more concerned about labor regulation than other managers were

Source: World Bank Enterprise Survey (2007). Note: Fast growing/slow growing/shrinking means employment grew faster/slower over previous year than median and shrinking means negative growth in employment. Similarly, high/low skilled means share of unskilled workers was above/below median. Only firms in the manufacturing sector have information on skills whereas fast/slow growing and part-time status is for all firms.

One important difference was that faster growing firms were more likely to say that labor regulations were a problem than slower growing firms. Whereas about 18 percent of slow growing or shrinking firms (in terms of employment) said that labor regulation was a problem compared to close to one-quarter of fast growing firms that said the same (see Figure 69). The difference was statistically significant after controlling for other variables that might affect perceptions about labor regulation (see Appendix 7.1).

This might not be surprising. Firms that are growing are more likely to have to hire new workers and so they are especially likely to suffer when labor regulation is burdensome. Firms with little growth will find restrictions on hiring and firing less burdensome since they will have less need to adjust their workforce size and will probably be less likely to need to require overtime from existing workers.

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Firms that are shrinking are also more likely to say that regulations are a burden. This suggests that labor regulation is likely to be a constraint on both entry and exit and so is likely to contribute to problems associated with reallocating resources from slow-growing or shrinking sectors to fastgrowing sectors. World Bank (2007a) notes that this type of re-allocation of resources has been a problem in Bulgaria and, as a result, has contributed little to productivity growth.

Although growing and shrinking firms were more likely to say that labor regulation was a serious obstacle than slow growing firms were, it is important to note that even shrinking and fast growing firms did not rate labor regulation among the very top concerns. Based upon the percent of firms that said it was a problem, labor regulation ranked as the 8th most serious concern for shrinking firms and the 9th most serious constraint for fast growing firms. In this respect, it seems unlikely that labor regulation is a serious problem for even these firms.

As discussed below, very few firms in the Enterprise Survey report that they hire either part-time or temporary workers (only about 15 percent of manufacturing firms said that they had either in 2007). This is consistent with other evidence that suggests that employment practices are not very flexible.109 With this proviso that few firms have part-time or temporary workers, these firms were more likely to say that labor regulation was a problem than other firms were. Given the difficulties associated with hiring part-time workers in Bulgaria (World Bank, 2007a), it is probably not surprising that these firms were considerably more likely to say that labor regulation were a serious problem than other firms (38 percent compared to 17 percent). It ranked as the 7th greatest concern for these firms, compared to the 13th greatest for firms without part-time or temporary workers.

Finally, firms with low-skilled workers are also more likely to see labor regulation as a problem than firms with more skilled workers (see Figure 69). One possibility is that these firms are more likely to need flexible workforces than firms with more skilled workers. But it is also possible that this might be because these firms are, on average, growing faster than other firms. As discussed in Chapter 1, a significant share of investment has been in relatively low-skilled sectors. Moreover, in the Enterprise Surveys, growth has been slightly faster among firms with more unskilled workers (see Figure 70). In this respect, it is possible that this result partly reflects that labor regulations make it both harder and riskier to hire new workers. Once again, although concern about labor regulation is greater among firms with low skilled workforces, it also does not rank among the top concerns for these firms either. For each group, it ranked as the 11th greatest constraint out of the 15 constraints that the survey asked about. In this respect, it is not clear that it is an especially great problem for these firms either.

median log growth rate

Figure 70: Employment at firms with unskilled workers has been growing faster than employment at other firms in Bulgaria 20% 15% 10% 5% 0%

High Skilled

Low Skilled

All full-time Some partpermenent time/ temporary

Source: World Bank Enterprise Survey (2007).

Note: High/low skilled means share of unskilled workers was above/below median. Only firms in the manufacturing sector have information on skills and full-time/part-time status whereas fast/slow growing is for all firms.

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IV. Labor flexibility There is limited possibility for worker force to engage in flexible arrangements in Bulgaria. Fulltime labor contract are by far the most common type of contract in Bulgaria. In 2007, 92 percent of workers had this type of contract with only 6 percent having temporary contracts and the remainder part-time contracts.110 Part-time employment Very few of the enterprises in the Enterprise Survey reported that they had any part-time workers.

Less than 10 percent of manufacturing firms in the Enterprise Survey had any part-time workers.

This appears to reflect the very low level of part-time employment among firms in Bulgaria. Parttime workers have consistently made up less than 4 percent of workers for the average manufacturing firms in Bulgaria since 1998 (see Figure 71). The share of part-time workers is far lower in Bulgaria than the average for the EU (see Figure 72). Although part-time employment is also less common in the other new EU entrants than in the average country in the EU, it is particularly uncommon in Bulgaria. % of workers that are part-time in manufacturing firms in Bulgaria

Figure 71: On average, manufacturing firms in Bulgaria report having few part-time workers 5% 4% 3% 2% 1% 0%

1998

1999

2000

2001

2002

2003

2004

2005

Source: Firm census data provided by NSI. Note: Only includes manufacturing firms.

There is not much information or research on why part-time employment is so uncommon in Bulgaria, even compared to the other new EU entrants. The National Statistical Institute asks parttime workers whether they are part-time because they ‘lack work, or no full-time job is available’.

Since 2003, about 60 percent of part-time workers have said this was the case. This suggests that although most part-time workers would like to have a full-time position, a significant share (about 40 percent) do not want full-time employment. Moreover, this does not provide any information on whether people that are unemployed or are otherwise out of the labor force would like to be employed part-time.

Table 46: Part-time employees in Bulgaria

Total part-time employees % of part-time workers that said they are part-time because of no full-time jobs available Source: NSI, LFS.

Q3 2003

Q3 2004

Q3 2005

Q3 2006

Q3 2007

56,800

65,900

52,100

57,300

53,800

60.9

61.2

62.5

58.1

61.2

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20 15 10

Lithuania

Poland

Romania

Slovenia

Estonia

Latvia

Czech Repuplic

Hungary

Slovakia

0

EU (27 countries)

5

Bulgaria

% of workers that are part-time

Figure 72: Part-time employment is less common in Bulgaria than in other EU countries EU

Source: Eurostat.

Note: In contrast to previous figure, this includes all workers (i.e., not just manufacturing).

Taking this into account, there are several possible reasons for the low number of part-time workers.

• Recent labor shortages. One possibility is that recent labor shortages might force employers to offer stable, full-time employment to attract and retain employees. If workers see part-time employment as unattractive, firms that would like to hire part-time employees might be unable to do so. This, however, does not explain the low-level of part-time employment during the earlier period of high unemployment (e.g., before 2003). Further, unemployment remains high among groups that traditionally favor part-time employment (e.g., young people and older workers near retirement).

• No well-developed culture of part-time employment. To the extent that employers are not used to hiring part-time workers and employees are not used to benefiting from such flexible work arrangements, part-time work might be low for cultural reasons. During the period of high unemployment, even when people were formally hired as part-time, they sometimes had to work full-time with payments for extra work being made illegally. High unemployment meant that it was difficult to combine in one and the same time two or more part time jobs, because of the low labor demand.

• Overtime work. As noted in Appendix 7.4, the labor code allows for overtime. It is possible that employers might prefer this option for providing flexibility rather than part-time employment.

Bureaucratic burden of hiring part-time workers. During discussions with employers, • some suggested that the bureaucratic burden of hiring part-time workers is high in Bulgaria. They suggested that it is nearly as burdensome to hire a part-time worker as a full-time worker, making it less attractive to do so, especially for short-term employment.

• Informality. As noted in Chapter 1, there appears to be a large number of ‘informal’ workers in Bulgaria. If it is easier to hire part-time workers informally, this might partly explain the low number of part-time workers in the formal labor force (i.e., with formal labor contracts).

As noted above, recent changes in legislation might have made it more attractive for people to enter part-time employment. In particular, part-time worker cannot be placed under less favorable conditions because of their part-time status. In particular, part-time workers should: (i) receive information on all vacancies and open positions that are available in the company; (ii) get access to professional training and (iii) may not be placed under less favorable conditions solely on the grounds of their part-time status. To the extent that the low-level of part-time employment reflects low demand for part-time jobs (i.e., if the main problem is either recent labor shortages or a culture

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that discourage part-time employment), these measures might make part-time employment more common. On the other hand, if the main burden is bureaucratic (i.e., firms do not like to hire parttime workers because it is too burdensome to do so), the impact of these changes is not likely to be large.

Without more information, it is not possible to determine the main factors driving the lowlevel of part-time employment. This is an additional area where further analytical work might be useful.

Self-employment Self-employment is highest in Agriculture, hunting, forestry and fishing (65 percent of total employment in 2007), Wholesale and retail trade (about 22 percent). The highest dynamics of selfemployed is witnessed in the ‘Financial intermediation, Real Estate, Renting and Business Activities” and the ‘Construction’, due to the boom in these sectors. However, in general, the number of selfemployed remains relatively low compared to the total number of employed.

During the initial years of transformation from centrally planned to market economy, the Bulgarian government encouraged entrepreneurship and self-employment grew. Eventually, the transformation process from a status of sole traders to employers or to employees has been completed. It is unlikely that the number of self-employed in Bulgaria will increase significantly in the near future. However, since flexibility and mobility of the labor are interrelated, it could be also assumed that, for the moment, that they are at levels that could hardly be considered as factors that are increasing labor productivity. % of workers that are self-employed

Figure 73: Relative share of the self-employed to the total number of the employed 35 30 25 20 15 10 5 0

2000 Source: HLFS, NSI.

2001

2002

2003

2004

2005

2006

2007

V. Summary and policy recommendations Firms in Bulgaria were very concerned about the education and skills of workers. More firms said that this was a serious problem for their firm than any other area of the investment climate except corruption, instability, and unfair competition with the informal sector. Moreover, it appears to be a particular concern for innovative firms and firms in the IT sector. Given the strong link that worker education and skills and innovation have with improvements in productivity (see Chapter 2), worker skills are a significant concern.

Low unemployment rates among highly education workers suggest that improvements in the tertiary and secondary vocational education systems are important. Although an analysis of the education system goes beyond the scope of the Investment Climate Assessment, two recent World Bank reports (World Bank, 2007a; 2008a) suggest ways that the system could be improved and that young people could be encouraged to complete their education. These include expanding the network of adult training centers, VET schools, private providers and other alternative training opportunities and adjusting their curricula so that certificates obtained by graduates are recognized and valued by employers.

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Encouraging young people to enter tertiary education would be useful in both combating youth unemployment—which is particularly high among poorly educated youth—and reducing skill constraints. Possible options including enhancing options for financial support for university students, improving the quality of secondary education in non-profiled schools, delaying early selection of students, allowing multiple pathways into tertiary education, and expanding the number of occupationally-oriented tertiary colleges (World Bank, 2008a). Improving the market relevance of degree programs by promoting competition among tertiary institutions might also be worth considering. Finally, increasing the output of tertiary science and engineering graduates would also be useful through appropriate reforms such as strengthening university links with employers and improving university governance.

Related to this, people who have not completed secondary education could be encouraged to improve their skills through life-long learning. This would increase the broad base of available pool of skilled labor for skills-intensive industries and would reduce high levels of unemployment and inactivity among these potential workers. Second chance education can improve adults’ basic skills and open a path back into formal vocational training programs. The Government has taken some steps to do this, including re-opening the formal training system to early school leavers through literacy courses managed by the Employment Agency and lowering minimum entry requirements to allow graduates from literacy courses to enter vocational training. Specially designed training for people over 50 might also be useful as this could improve the quality of aging working force.

However, the design for the training system for adults over 50 should be carefully considered so that its design reflects best practice in Europe.

Although improvements in education are important, it is also important to remember the skills of workers are not only the responsibility of the Government. Firms play a vital role in improving the skills of their workers through formal and informal training. Few firms in Bulgaria, however, provide training to their workers. So the question is why not?

There are several possible market failures that might discourage firms from providing training.

One problem is that managers, especially of small firms, might not be aware of the magnitude of the benefits of training, the best practices related to providing training, or the availability, offerings and cost of public and private courses. This, in turn, might make them unwilling to invest in their workers. To the extent that information is the problem, the most appropriate policy response is to disseminate information on the benefits and effectiveness of different types of training.

A second issue is turnover and poaching of skilled workers reduces firms’ incentives to train their workers. This can be a particular problem in countries such as Bulgaria where unemployment is very low among skilled and educated workers. Collective action is needed to resolve these problems, so that firms can internalize these externalities. Broadly speaking there are at least three approaches that countries have used to promote firm-level training: (i) payroll levies that firms can reclaim if they invest in training their workers (see Box 12); (ii) tax incentives for firm-level training; and (iii) matching grants that provide funds to offset the cost of training. Given the low level of the corporate tax in Bulgaria, tax incentives might be difficult unless it is targeted at the payroll tax.

These approaches both reduce financing constraints and correct market failures by reducing the out-of-pocket cost of training.

Having a better understanding of why firms—even those that see worker education and skills as a problem—do not provide training would provide important background on the actual barriers to training and would give better information on the most effective way forward. Collecting additional detailed data on this topic would therefore be extremely useful.

Given the uncertainty about both the reasons why firms do not provide training and on appropriate policy responses, it is important to rigorously pilot, test and monitor any program designed to promote firm-level training. Before committing public funds to large scale responses, it will be important to assess the effectiveness of any proposed program. Programs should therefore be rigourously piloted and monitored to assess both effectiveness and efficiency.

In addition to the broad approaches outlined above, other steps might also encourage training.

To improve access to finance for life-long learning (LLL), public-private partnerships might be encouraged to provide funding for training. Similarly, local municipalities might be able to engage

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more actively in providing matching funds to NGOs in managing projects from the OPs of the EU Structural Funds that target LLL activities. Finally, the government might be able to promote collective agreements that include clauses which relate to provision of vocational training. At the same time the government, together with employer’s and employee’s organizations might consider ways to provide restitution for investment in training that the employer has made during the year if the employee leaves the company.

Box 12: Training Levies Training levies are a very popular way of encouraging training that have been used in over 30 countries including Argentina, Brazil, Chile and Hungary (Dar and others, 2003). A payroll tax is levied on the firm with firms receiving exemptions or rebates by providing internal or external training to their workers.

International experience with these schemes suggests several important lessons (Dar and others, 2003; Desai and Goldberg, 2007; Middleton and others, 1993).

• Employer buy-in is vital for these funds to be effective. If not, employers see these funds as just an additional tax. One way to increase buy-in is to ensure that employers and other social partners are closely involved in the governance of levy funds. Buy-in also ensures that the training system is responsive to the needs of key stakeholders.

• Administrative efficiency and transparency are also important. This means having an effective system to collect revenues and in processing and reimbursing claims quickly and efficiently.

• Levy funds should be earmarked for training and not diverted to other purposes.

• Policies should be designed to increase competition in training provision from both public and private providers. If the fund becomes a way of simply providing financing to public vocational training institutes, it will lose credibility.

• Governments should play active roles in evaluating the effectiveness of the scheme and to ensure quality control among both private and public training providers.

One important caution is that there is good evidence that training levies do not benefit micro and small enterprises (Dar and others, 2003). This can be because small firms avoid or evade the levy or because the main recipients are better educated and highly skilled workers—most of whom work in larger enterprises. The administrative cost of claiming reimbursements can also be higher for small firms, discouraging them from submitting claims. If this is the case, small firms will see the levies simply as another payroll tax and its imposition could encourage evasion and avoidance. The low participation of small firms is likely to be a concern in Bulgaria given that training was even less common among small firms than among larger firms. Active approaches aimed at improving technological capacity and reducing information constraints are therefore especially important for these firms.

In contrast to worker education and skills, few firms saw labor regulation as a serious obstacle to their operations and growth. Objective data is generally consistent with this. Bulgaria compares favorably with other countries in the EU with respect to most aspects of labor regulation in the Doing Business report. In particular, Bulgaria compares favorably with respect to the difficulty of hiring and firing and firing costs are low in terms of weeks of wages. This suggests that recent changes in labor regulation (see Appendix 7.3) might have reduced the burden that labor regulation has had on firms. Overall, this suggests that reform in this area might be a lesser priority than reform related to worker education and skills in the near-term, especially in an environment of strong labor demand.

Revising other labor legislation and regulations in line with EU requirements might be useful (World Bank, 2007a). World Bank (2007a) recommends that a new labor code be drafted, arguing that the current code is too prescriptive. It argues that it is vital that the social partners—employers and representatives of the employees—should be given a large role in determining employment relations since these are the parties that are best able to develop rules that allow for a flexible work force without sacrificing an appropriate level of social protection.

Within the framework of consultation with the social partners, it would be worth considering measures to increase flexibility with respect to working hours and part-time work. This is another area where Bulgaria compares less favorably with other countries with respect to the objective indicators. Other evidence also suggests that this is a problem. There are very few of temporary or part-time workers in Bulgaria and the few firms that do hire part-time and temporary workers were far more likely to see labor regulation as a serious constraint than other firms were. Further work looking at the reasons for low part-time and temporary employment would be very useful.

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Another area where improvement might be possible is with respect to nonwage labor costs such as social security payments and payroll taxes. Although lower than in many of the new EU entrants, they are higher than in the best performing EU countries. As discussed in Chapter 6, further reducing social security contribution payments may be beneficial as it will reduce the incentive that firms have to engage in informal practices. As noted in the ABC Report (World Bank, 2007a), this would have to be done in a fiscally sustainable manner. Although reducing taxes might reduce informality and raise employment, additional revenue measures might be needed to ensure sustainability.

Monitoring the functioning of 10 specialized labor offices for the Roma minority is needed. As it regards the Roma minority labor force, the functioning of the 10 specialized labor offices for the Roma minority, which were recently established, could be monitored annually in order to assess their effectiveness in terms of number of teaching modules offered, number of Roma that attended and successfully completed the training programs, assessment of the qualifications acquired, and finally, the number of Roma that managed to be hired in the labor market on part-time or permanent positions.

Chapter 8: Access to Finance In earlier surveys in the late 1990s and early 2000s, managers consistently reported that access to finance and the cost of financing were among the biggest—if not actually the biggest—problems that their firm faced (see Chapter 5). This was not the case in the 2007 Enterprise Survey. Access to finance did not rate among the top concerns of managers, even in the manufacturing sector where managers were more concerned about access to finance than they were in other sectors.

This chapter asks two questions. Do objective indicators of access to finance support the idea that this constraint has become less binding to firm operations and growth? And, if so, why is this the case?

I. The Financial Sector in Bulgaria The financial crisis of 1996-1997 resulted in a serious loss of confidence in the banking system and its institutions. The Government, however, responded aggressively to the crisis, introducing many important reforms. It implemented a Currency Board Arrangement (CBA), strengthened the legal and regulatory framework, and worked to improve and strengthen implementation and enforcement. The new legal framework imposed conservative requirements on capital adequacy and liquidity, reducing the banks’ capacity to lend. Coupled with diminished confidence in the banking system, this led to a large contraction in bank operations after the crisis. By 1996, only 30 of the 78 banks that existed in 1991 were still operating.

Credit to the Private Sector After an initial contraction in bank lending, the financial sector entered a period of stabilization and then expansion. Growth of private credit between 2002 and 2006 was very rapid—averaging 35 percent a year in nominal terms between 2002 and 2007. Although slower than in the new EU members with the fastest nominal growth rates (see Figure 74), it was faster than the average rate (25 percent).

Figure 74: After a half-decade of rapid growth, credit to the private sector was higher than in many of the other recent entrants to the EU Romania

Latvia Estonia

Latvia

Slovenia

Estonia

Hungary

Lithuania

Lithuania

Slovenia

Czech Rep.

Hungary

Slovak Rep.

Poland

Poland

Slovak Rep.

Romania

Czech Rep.

Bulgaria

Bulgaria 0

25

50

75

100

Private Credit as % of GDP

0%

10% 20% 30% 40% 50%

Growth in private credit (average, 2002-2007)

Source: World Bank (2008c); Bulgarian National Bank ( 2008b); International Monetary Fund (2008).

Note: Data on private credit to GDP are for 2006 for all countries except Bulgaria (2007). Average growth rates are for 2002-2007 for all countries except Slovenia and Estonia (2002-2006).

137

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The Bulgarian National Bank attributed the rapid growth to several factors including: •

Restructuring and privatization of the banking system and the access to foreign capital, technologies, organizational and managerial knowledge and skills, as well as debt resources; The low rate of borrowing of the households and firms (in early 2002, the ratio of credits to GDP was 15 percent); Low world-wide interest rates.

• •

By the end of 2006, credit to the private sector was comparable to credit in the other new members of the EU (47 percent of GDP). Although lower than in the best performing countries (see Figure 74), it was close to the average (55 percent of GDP). Moreover, this rapid growth continued into 2007. By 2007, credit was equal to 68 percent of GDP—higher than in all but the best performing of the new EU members. Although a significant portion of this credit growth was due to an increase in lending to households, about 60 percent of private sector lending in 2007 was to the corporate sector (International Monetary Fund, 2007b).

Because of concern about the rapid growth—and the possibility that it could lead to a deterioration in loan quality and exacerbate macroeconomic imbalances—the Bulgarian National Bank (BNB) took several steps in early 2005 to limit bank lending. These included strengthening prudential supervision, adopting liquidity measures, strengthening the credit registry, and improving access to it. Finally, the BNB introduced additional compulsory reserves for banks when credit growth exceeded 6 percent per quarter. Although the growth of bank credit slowed through the end of 2006, the IMF concluded that these steps were largely ineffective since the growth was largely shifted to non-bank institutions and cross-border lending (International Monetary Fund, 2007b).

The BNB lifted the limits in January 2007. After credit growth accelerated again, in September 2007, the BNB raised compulsory minimum reserves that the banks have to maintain in BNB from 8 percent to 12 percent of the bank’s deposit bases. Growth, however, remained very rapid in the final quarter of 2007 (63 percent at an annual rate according to the BNB data) and the current account deficit continued to increase, reaching over 20 percent of GDP in 2007 (see Chapter 1).

Credit to private sector (% of GDP)

Figure 75: At the end of 2006, credit to the private sector in Bulgaria was comparable to credit in other countries with similar levels of per capita GDP 300

Others EU 10 Bulgaria Fitted line

200

100

0

$0

$10 000

$20 000 $30 000 Per Capita GDP (PPP intl $)

$40 000

Source: World Bank (2008c).

Although credit growth has been extremely rapid since 2002, it is important to note that this is from a very low base. At the end of 2006, credit to the private sector in Bulgaria was roughly equal to the average for other countries with similar levels of GDP (see Figure 75). The rapid growth in 2007 means that credit is now higher than in similar countries.

Interest Rates Although the expansion of the banking sector has increased credit, lending interest rates remain high (see Table 4). Moreover, spreads in Bulgaria are currently among the highest among the new EU entrants.

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Table 47: Comparison of borrowing rates in the new EU member states (%) 2001

Bulgaria Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia

2003

Deposit rate

Lending rate

Deposit rate

2.92

11.11

2.93

2.87

7.20

1.33

4.03 8.40 5.24 3 11.80 26.87 6.46 9.81

7.78 12.12 11.17 9.63 18.36 45.40 11.24 15.05

2.40 10.98 3.02 1.27 3.71 11.02 5.33 5.95

Source: International Financial Statistics, IMF.

2005

Lending rate

8.54 5.95

5.51 9.60 5.38 5.84 7.30 25.44 8.46 10.75

Deposit rate

Lending rate

3.08 1.17

8.66

2.13 5.17 2.78 2.40 2.79 6.42 2.44 3.18

4.93 8.54 6.11 5.27 6.83 19.60 6.68 7.80

5.78

2007

Deposit rate

Lending rate

3.68 1.32

10 5.79

4.37 6.81 6.06 5.40 --6.70 --3.60

6.46 9.09 10.91 6.86 --13.35 --5.91

Why are spreads so high? Various factors might play a role. Systemic risks, such as macroeconomic volatility might be important. Bulgaria’s current account deficit (21.6 percent of GDP) is very high and inflation reached double digits in 2007 (see Chapter 1). Another possible contributor is weaknesses in the contractual and informational environment. For instance, poorly defined and difficult to enforce creditor rights, deficient accounting and disclosure practices, issues related to corporate governance principles, lack of coverage for credit bureaus all could contribute to high interest rates for business loans. Finally, low levels of competition in the banking sector might also play a role. There are currently only 29 banks operating in Bulgaria and the top five have a market share of close to 60 percent. Although some of these issues are discussed later in the chapter and in Appendix 8.1, a more complete analysis will be completed in an upcoming World Bank-IMF joint mission to Bulgaria of the Financial Sector Assessment Program (FSAP).

Non-banking financial sector Since 2005, non-banking sector investments and savings have become more important in Bulgaria.

Among the factors that have contributed to the development of capital markets are: establishment of a regulatory framework for mutual funds, reform of the pension insurance system, the state’s tax policy (allowing for generation of untaxed gains), and the BNB’s restrictions on commercial banks lending (BSE-Sofia, 2008). However, the capital market remains small in absolute terms.

Leasing companies and consumer credit companies have expanded in Bulgaria. They have contributed to the credit growth from the non-banking financial sector. According to data from BNB, liabilities of leasing companies have grown from 1.6 b. Lev (€0.8 million) in the first quarter period of 2006 to 2.8 billion Lev (€1.4 billion) in the same period in 2007 and 5.1 billion Lev (€2.55 billion) in the same period in 2008. In fact, between 2005 and 2007 they have increased by 2.5 times their assets (see Appendix 8.1). In recent interviews (2008), the FSC and the BNB have suggested that leasing companies and consumer credit companies should be more heavily supervised. A thorough review of this proposal is needed. The up-coming Diagnostic Review on Consumer Protection in Financial services of the World Bank in the autumn of 2008 might be helpful in this respect.

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II. Perceptions about Access to Finance As discussed in Chapter 3, firms were far less likely to say that access to credit was a serious problem in 2007 than they were to do so in earlier years. Whereas access to credit and the cost of financing ranked among the top concerns in most earlier studies, it only ranked 13th out of 15 constraints when ranked according to the number of firms that said it was a serious problem and 5th of 15 when ranked by the number of firms that said it was the biggest constraint that they faced.

These improved perceptions probably reflect the rapid growth in credit that has taken place in recent years. That is, credit growth might have relieved concerns of firms about access to finance.

This question will be discussed in more detail in the section on objective indicators of access to finance.

Differences in access to credit by firm type So, what kind of firms said that access to credit was a serious problem?111 As noted in Chapter 3, managers of small firms and managers of firms in the manufacturing and other service sectors were more likely to say that access to finance was a serious problem than other firms. But other characteristics are also important. In particular, perceptions differ between firms with and without loans and differ depending on the reason why the firm does not have a loan.

For this analysis, firms are divided into four groups: (i) firms that applied for a loan in 2006 and were not rejected; (ii) firms that applied for a loan in 2006 and were rejected; (iii) firms that did not apply for a loan in 2006 but said that they did not want a loan; and (iv) firms that did not apply for a loan in 2006 but gave some other reason for not applying. For firms in the fourth group, the most common reason was that interest rates were not favorable (see Table 48). Appendix 8.2 presents a more detailed econometric analysis that confirms the graphical results discussed here.

80% 60% 40%

Did not invest in 2006

Invested in 2006

Did not apply for loan and did not want loan

Received loan in 2006

0%

Did not apply for a loan but want loan

20%

Loan application rejected in 2006

% of firms saying finance is a serious problem

Figure 76: Many firms without loans do not report that access to credit was a problem—the most likely reason is that many of these firms do not feel that they need credit

Source: World Bank Enterprise Survey (2007).

Firms that applied for loans in 2006 but were rejected were far more likely to say that access to credit was a serious problem than other firms—over three-quarters of these firms said access to credit was a serious problem (see Figure 76). This is probably not surprising given that these firms wanted to get a loan but failed to do so. Firms that did not apply for loans, but gave a reason other than not wanting or needing a loan as the main reason why they did not were also concerned about access to finance.

But managers of firms that received loans in 2006 were also likely to say that access to credit was a problem—about one-quarter said it was a serious problem. This strongly suggests that they were unhappy about the loan that they received. For example, they could be unhappy about the size of the loan or the interest rate. Not surprisingly, very few of the firms that said that they did not apply for a loan in 2006 and did not do so because they did not need one (over half of the firms in the survey) said that access to credit was problem. This is also not surprising.

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141

It is also interesting to look at whether firms that are investing are more or less likely to say that access to finance is a serious constraint (see Appendix 8.3). If firms that are not investing are the ones that tend to see access to finance as a constraint, this might suggest that problems with access to finance are preventing them from doing so. On the other hand, if the reverse is true (i.e., firms that are not investing do not see access to finance as a constraint), this suggests that access to finance might not be the main constraint on their investment (e.g., other factors discourage investment). In Bulgaria, it seems that most firms that are not investing do not see access to finance as a serious constraint, suggesting that access to finance is probably not the main reason why they are not investing.

Overall, this analysis suggests that the biggest problem for firms that say access to credit is a problem might not be that they are unable to get a loan at all. On average, firms that did not apply for a loan in 2006 were less likely to say access to credit was a serious problem than firms that applied for them. This appears to be because most firms without a loan do not want one. Although firms that had loan applications rejected were most concerned about access to credit, this represents only a small number of firms (only about 25 or 2.5 percent of the sample). Concern about access to credit from firms with loans suggests that this might be either because they cannot get enough credit or that credit is not being extended on terms that are as favorable as managers would like.

III. Objective Indicators of Access to Credit Chapter 5 looks at whether there are systematic differences in firm perceptions across different types of firms in Bulgaria. The results suggested that managers of manufacturing and other service firms tended to be more concerned about access to finance than managers of firms in the IT and retail trade sectors. Also, as in many countries, managers of small firms tended to be more concerned about access to finance than managers of large firms. Even for small firms, however, access to finance did not rank among the top concerns.

Loans and Overdrafts As discussed in Chapter 5, firms in Bulgaria were very concerned about financing in 2004—access to financing and the cost of financing ranked as the first and second greatest constraints in these years based upon the number of firms that said they were serious problems. The objective data are mostly consistent with this. When compared with firms from the other EU accession countries in 2005, firms in Bulgaria were less likely to say that they had a loan than in all but two countries and on average financed less investment with bank financing than in all but three countries.

Access, however, appears to have improved significantly. Firms have become far more likely to have financing from the financial sector in recent years (see Figure 74). At the end of 1998, just after the financial crisis, about 8 percent of firms in Bulgaria had long-term liabilities to financial institutions and about 26 percent had any liabilities to financial institutions. For the most part, the percent of firms with long-term loans stayed at about the same level until 2001, when it started to slowly increase. By 2005, about 25 percent of firms had long-term liabilities to financial institutions and about 40 percent had any liabilities. The increase between 2003 and 2005 was fairly steep.

Evidence from the Enterprise Surveys is consistent with this, also indicating rapid growth in bank credit over this period. Although the Enterprise Survey only provides information on bank loans rather than all types of financing from bank and non-bank financial institutions and samples are small in 2004 and 2005, the Enterprise Survey data also suggests rapid growth in credit.

By 2005, about 39 percent of firms in the BEEPS survey reported they had a loan—compared to 34 percent in 2004. By 2007, 44 percent of firms said the same. If the share of firms that had bank financing had been the case at the time of the 2005 BEEPS survey, Bulgaria would have ranked in the middle of the pack in this respect by 2007. Similarly, although in 2004, Bulgaria would have ranked below most countries (relative to their 2005 scores) with respect to the average amount of investment financed with bank financing, it ranked second in 2005 and by 2007, it would have ranked top.112 In this respect the objective firm-level data appears consistent with both the macroeconomic data and the perception-based data. Access to credit appears to have significantly improved since the earlymid 2000s in Bulgaria.

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Figure 77: Access to credit—including long-term credit (over 1 year)—has increased significantly since 1998 45%

Any Credit Long-term Short-term

35% 30% 25% 20% 15%

2005

2004

2003

2002

2001

0%

2000

5%

1999

10%

1998

% of firms with long-term and short-term loans

40%

Source: Firm Census Data from National Statistical Institute.

Note: Any credit means firm has any liabilities towards financial institutions at the end of that year. Long-term loans are loans of over one year while short-term loans are loans of less than one year.

Figure 78: In 2007, firms in Bulgaria financed as much investment with bank financing and were as likely to have loans as firms in most of the other countries in the region in 2005 Slovenia Hungary

Slovenia Hungary

Latvia

Latvia

Romania

Slovakia Lithuania

Poland

Romania

Estonia

Lithuania Slovakia

Estonia Poland Czech Republic

Czech Republic

Bulgaria 2005

Bulgaria 2005

Bulgaria 2004

Bulgaria 2004

Bulgaria 2007

Bulgaria 2007 0%

25%

50%

75%

0%

10%

20%

30%

% of firms with bank loans % of investment financed with bank financing Source: World Bank Enterprise Surveys; EBRD-World Bank Business Environment and Enterprise Performance Survey (BEEPS).

Reasons for not applying for loans Firms that did not apply for a loan in 2006 were asked why they did not do so. The most common reason for not doing so was that they did not need a loan. Nearly two-thirds of firms that did not apply—and nearly three quarters in the IT sector—said they did not need one. The next most common response was that interest rates were unfavorable. About 14 percent of firms—or about 40 percent of firms that did not say that they did not need one—gave this response. Other responses were far less common.

Some of the firms that did not apply for a loan in 2006 might have already had a loan and, therefore, might have said that they did not need one. Although there is no definitive way to know whether this is that case, it seems likely that many did not have a loan. Of the firms that reported that they did not apply for a loan in 2006, about one-third had a loan in 2007. This was the case for firms that reported both that they did not need a loan and for firms that gave another reason. This may suggest that access to finance has further improved between 2006 and 2007 for firms that previously were unable to obtain loan financing.

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Table 48: Most firms that did not apply for a loan in 2006 reported that they did not need a loan All

Manufacturing

Retail

Information Technology

Other Services

No need for a loan Application procedures are too burdensome Interest rates are not favorable

63

60

69

77

63

7

17

6

2

3

14

11

19

5

16

Collateral requirements are unattainable

4

6

3

14

3

Size or maturity of available loan are insufficient Did not think it would be approved

3

1

…

1

5

1

3

…

1

…

Other

7

3

3

1

11

Source: World Bank Enterprise Survey (2007).

Moreover, this is supported by other data from the Enterprise Survey (2007). For firms that did not apply for a loan in 2006, about 30 percent had loans approved in 2007 and about 60 percent had had loans approved in 2006. For the firms that had loans approved in 2006, since they reported that they did not apply for a loan in that year, this suggests that they had applied for the loans earlier (e.g., in 2005) but that they were not approved until 2006. In any case, it seems likely that many of the firms that did not apply for loans in 2006 did not have a loan at that time.

Overall, this evidence is consistent with earlier evidence. Although some firms still do not have credit, many of these either do not want a loan or feel that interest rates are too high. This is true even for small enterprises—about 76 percent of microenterprise managers and 57 percent of small enterprise managers that did not apply for a loan said they did not need one and an additional 17 percent of each said that interest rates were too high. And few firms reported not applying because they did not think they could get one at all (about 1 percent of firms that did not apply), could not get a loan of sufficient size or maturity (about 3 percent) or did not have sufficient collateral (about 4 percent).

Characteristics of loans The previous results suggest that access to credit has improved in recent years and many, although not all, firms without loans either do not want or need loans or do not want them at current interest rates. This, however, does not mean that those with loans are able to get long-term loans at attractive rates.

In addition to broad questions about whether firms have loans or overdraft facilities and if not, why not, it is also interesting to look at the characteristics of these loans. Most of the loans are quite recent—more than half of the firms with loans received their most recent loan in 2007. This is especially notable given that about half of the interviews were conducted in the third quarter (i.e., before the year was over).

Moreover, over 90 percent of firms with loans had received their loans in 2005 or later—in fact only 3 percent of firms had received their most recent loan before 2005. This, of course, does not imply that firms had not received any loans before 2005—the question asks only about the most recent loan. It does, however, suggest that the expansion of credit might have had a significant impact on access to credit.

On average, the recent loans appear to have been large relative to both assets and sales. Because earlier loans are likely to have affected both assets and, potentially, sales, this analysis is restricted to loans granted in 2007. The median loan size in 2007 was equal to about 104 percent of the book value of assets (land, buildings, machinery and equipment) in 2006. Although book values can be misleading when equipment is old (i.e., it might accurately capture the actual ‘value’ of capital in production), the median loan size was equal to about one-quarter of what the manager thought it would cost to replace their current machinery and equipment with new machinery and equipment.

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Table 49: Characteristics of most recent loans Obs.

10th percentile

25th percentile

Median

75 percentile

90th percentile

Mean

Year loan was approved Duration of loan

438

2005

2006

2007

2007

2007

2006

390

1

12

24

36

60

32

Collateral as % of value of loan

316

70

100

130

150

150

128

69

6%

31%

104%

381%

1294%

393%

76

2%

8%

24%

53%

114%

59%

159

3%

5%

13%

25%

50%

22%

Loan relative to assets (total, book value) Loan relative to assets (M&E, replacement value) Loan relative to sales

Source: World Bank Enterprise Survey (2007).

Note: For loans size relative to assets comparisons are only for loans granted in 2007 (i.e., it compares loans in 2007 with assets in 2006 prior to any new investment from the loan proceeds.

Close to 80 percent of firms with loans said that collateral was required. The median amount of collateral required for the loan was equal to about 130 percent of the loan, with most amounts between about 100 and 150 percent of the loan value. In comparison, the median value of collateral needed for a loan (as percent of the loan amount) in Bulgaria stood at 159 percent in 2005. It is, however, high compared to neighboring economies, like Croatia. In a similar 2007 Enterprise Survey in that country the median value of collateral of 121 percent. In a 2005 survey in Turkey, the median value of collateral of 105 percent. This high value of collateral in Bulgaria at present might mean that some SMEs do not get sufficient financing. That is, although few firms reported that problems with collateral prevented them from getting a loan in 2006 (see Table 48), the loans might not be as large as it could be if collateral requirements were more modest.

Firms were also asked about the types of collateral they used for the most recent loans—many reporting more than one type. The most common form of collateral that firms reported using was land and buildings (62 percent of firms reported using this type of collateral), followed by the assets of the owners such as the owners’ house (34 percent). Fewer firms reported using machinery and equipment as collateral (27 percent) and very few reported using receivables of inventories as collateral (1 percent). In low and middle income countries with the most developed financial systems, firms can use movable assets and receivables as collateral. In this respect, Bulgaria does not appear as developed as some economies in that the types of collateral available appear more limited.

Another indication that Bulgaria’s financial markets remain less developed than in the most developed middle income countries is with respect to the availability of long-term financing. The median duration for the firm’s most current loan was about 24 months for firm with active loans at the time of the interview in the Enterprise Survey. This suggests that short-term loans are far more common than long-term loans (e.g., with a duration of 5 years or more) and makes the available loans more attractive for financing short-term working capital needs or short-term investment (e.g., computers) rather than long-term investment. Moreover, these data may actually overestimate the average duration of loans. Because short-term loans (e.g., one or two years old) in previous years will no longer be active if they were approved too long ago (e.g., in 2006 or 2005), these loans would be omitted from the survey. Focusing only on loans from 2007 (e.g., that will still most be active), about 60 percent were for one-year or less and only 5 percent were for more than five years.

Differences in Access by Firm Type In general, larger firms reported that they were more likely to have bank credit than small firms were (see Figure 79). Larger firms were more likely to have both bank loans and overdraft facilities than smaller firms. The differences are large and statistically significant even after controlling for other factors (e.g., age, sector, and ownership) that might affect access to credit (see Appendix 8.3).

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Other evidence also suggests that large firms have better access to credit than smaller firms. Firms were more likely to apply for loan in 2006 and, large firms that did not apply for a loan were more likely to say that they did not need one. Finally, although slightly more large and medium-sized had had applications rejected than small enterprises and microenterprises (see Figure 79), this appears to be because large firms are different than small firms in other ways that affect loan rejections. In particular, after controlling for other things that might affect whether loan applications are rejected, large firms appear to be less likely to have applications rejected than small firms are (see econometric analysis in Appendix 8.3).

Figure 79: Large firms have better access to finance than small firms 100%

Micro/Small Medium/Large

% of firms

75%

50%

Loan required collateral

No need for loan

Source: World Bank Enterprise Surveys (2007).

Loan application rejected

Firm has overdraft

Firm has loan

Firm has bank credit

0%

Applied for loan in 2006

25%

For firms that have loans, there is less evidence that large firms get preferential treatment. Large firms were more likely to say that collateral was needed to get the loan (see Figure 79). Moreover, although they reported slightly longer average loan durations (36 months compared to 30 months), the difference was not statistically significant.

Another interesting difference is that firms in the IT sector were less likely to have loans and overdrafts than firms in other sectors. After controlling for other factors, firms in the IT sector were about 17 percentage points less likely to have a loan and 22 percentage points less likely to have an overdraft (see econometric analysis in Appendix 8.3). They were also about 10 percentage points less likely to have applied for a loan in 2006. But this does not seem to be because they are unable to get access to credit. As discussed above, IT firms were less likely to say that access to finance was a problem (see Appendix 8.3) and IT firms that did not apply for a loan were more likely to say that they did not need one.

Other differences are discussed in the econometric appendix (see Appendix 8.3). The most notable remaining difference is that firms with land appear to be more likely to have loans, overdrafts, and to use bank financing to finance both working capital and investment. Given the importance of land as collateral, this might not be surprising. The issue of collateral is discussed in greater detail below.

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IV. Investment The main reason why we are interested in access to credit is that we are interested in firmlevel investment. When firms are able to get access to credit, they are able to invest to expand the production facilities and hire more workers. Investment is therefore important as a source of growth and as a way of achieving efficient capital allocation.

The previous results suggest that access to credit has improved significantly in Bulgaria in recent years. Has this increased investment? The evidence from the Enterprise Surveys suggests that it might have. Manufacturing firms in Bulgaria were more likely to report positive investment in 2006 than they were in 2003 (i.e., in the 2004 survey which asked about investment in the previous year)— about 62 percent of firms reported investing in 2003 compared to over 70 percent of firms in 2004 and 2006 (see Figure 2). Although comparable data on firm-level investment was not available in the 2004 survey, the results from the 2005 and 2007 surveys suggest that firms that did invest, invested more in 2006 than in 2004 (about 6 percent of sales compared to 4 percent of sales). If anything the estimate for 2006 might underestimate investment in 2006 since investment as a percent of sales includes investment in buildings in the 2005 BEEPS survey but omits investment in buildings in the 2007 Enterprise Survey.

Figure 80: Bulgarian firms were more likely to invest in 2006 than in 2004—although investment remained lower than in some other countries in the region Poland Romania Lithuania Latvia

Poland Estonia Hungary Romania

Slovakia Estonia Hungary Czech Rep. Slovenia

Czech Rep. Slovenia Lithuania Slovakia Latvia

Bulgaria 2003 Bulgaria 2004 Bulgaria 2006

Bulgaria 2004 Bulgaria 2006 0% 25% 50% 75% 100%

0% 2% 4% 6% 8% 10%

% of firms investing investment as % of sales (average) Source: World Bank Enterprise Surveys.

Note: Cross-country comparisons are only for manufacturing firms. Investment as percent of sales might be underestimated for Bulgaria for 2007 since it excludes investment in buildings. Data for countries other than Bulgaria are for 2004 from the 2005 BEEPS survey. Outliers more than 2 standard deviations from the mean are dropped from the means for investment as percent of sales.

Although investment has increased in recent years in Bulgaria, fewer Bulgarian firms invest in machinery, equipment and buildings in Bulgaria than in many of the other recent EU accession countries. In most of the recent EU accession countries, more than 80 percent of firms had positive investment. Although this excludes firms that invested in buildings in Bulgaria in 2006, this would not have much effect on results since only a very few firms in Bulgaria that reported no expenditures on machinery and equipment reported any expenditures on land and building. That is, including firms that had expenditures on land and buildings would increase the percent of firms with positive investment by only about 1 percentage point.

Bulgaria compares more favorably with respect to the amount of investment for firms that report positive investment. Although average investment in 2004 was lower as a percentage of sales in Bulgaria than in most other countries in the region, it was higher in 2006 in Bulgaria than it was in most of the other recent EU accession countries in 2004. Moreover, as noted above, the average for Bulgaria for 2006 includes investment only in machinery and equipment—not buildings. If buildings were included, Bulgaria would compare even more favorably.

There is also some variation in investment across different types of firms. An econometric analysis of these differences is presented in Appendix 8.4. The most consistent result is that larger firms

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invest more than smaller firms. Larger firms are more likely to invest and invest more as a percent of assets than smaller firms do (see Figure 2). The difference remains statistically significant and large after controlling for other differences between large and small firms (see Appendix 8.4). Based upon the econometric analysis, a firm with 100 workers would be between 12 and 13 percent more likely to invest and would invest between about 23 and 26 percent more as a percent of assets.

Domestic firms appear to be both more likely to invest and invest more than foreign-owned firms (see Figure 81). Although the difference is not statistically significant after controlling for other differences (see Appendix 8.4), this suggests that foreign-owned firms do not appear to invest more in Bulgaria than domestic firms do.

Another interesting question is whether access to bank credit increases investment. If some firms are credit constrained because they are unable to access the bank credit market, these firms will tend to invest less than other firms. There is a strong correlation between having bank credit –especially between having a loan rather than an overdraft—and investment. Firms that have bank loans are more likely to invest and invest more than firms that do not (see Figure 2 and Appendix 8.4). Once an indicator of whether the firm has a loan is included in the econometric analysis, the difference between large and small firms with respect to investment becomes smaller and often statistically insignificant. This suggests that the reason that large firms invest more is that they have better access to credit.

Figure 81: Although fewer firms used bank credit for investment in Bulgaria in 2004 than in most other EU accession countries, the rapid expansion means that this is no longer the case Bank Credit

Bank Credit

No Credit

No Credit

Domestic

Domestic

Foreignowned

Foreignowned

Medium/Large

Medium/Large

Micro/Small

Micro/Small

0% 10% 20% 30% 40% 0% 25% 50% 75% 100% % of firms investing investment as % of assets (median) Source: World Bank Enterprise Surveys; EBRD-World Bank Business Environment and Enterprise Performance Survey (BEEPS).

Note: Outliers more than 2 standard deviations from the mean are dropped from the means for investment as percent of assets.

Although this might suggest that firms are credit constrained—firms without loans invest less than firms with bank loans—it is difficult to assess whether this is the case with cross-sectional data. Firms with investment needs are more likely to demand bank credit than firms without and so any correlation between investment and use of bank credit could be due to this rather than to bank credit releasing investment constraints.

There is at least one reason to think that this might be the case. The question about investment asks whether the firm invested in 2006, while the loan question asks whether the firm had a bank loan at the time of the interview. If the firm had a loan, the firm was then asked when it got its most recent loan. It is therefore possible to divide the sample into two groups—firms that got their most recent loan in 2007 and firms that got their most recent loan in 2006 and earlier. If access to credit was an important determinant of investment, firms that got their most recent loan after 2006 would be less likely to invest in 2006 than firms that got their most recent loan in 2006 or earlier. Of course, this evidence is not entirely conclusive because many firms that got their most recent loan in 2007 might have already had a loan in 2006. But it seems reasonable to assume that at least some of the firms that got their most recent loan in 2006—especially given the expansion of credit over this period—did not have a loan before that.

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In general, firms that got their most recent loan after 2006 (i.e., after the investment occurred) were no less likely to invest and did not invest any less than firms that received their loan in 2006 or earlier. Although, as discussed above, this does not conclusively show that causation runs in the opposite direction, it suggests that it might.

V. The Institutional Environment The Doing Business report (World Bank) has two sets of indicators that show how well credit markets function—one on credit registries and one on legal rights of borrowers and lenders.113 Credit registries can expand access to credit for the corporate sector by collecting and distributing information on whether borrowers are credit worthy. This allows lenders to easily assess the risk associated with a new loan without requiring that they build a personal relationship with the borrower. As a result, credit can be allocated more efficiently (World Bank, 2007). This allows firm managers to rely on their corporate profile, instead of personal connections to obtain credit.

Table 50: Bulgaria stands fairly well in terms of “getting credit” indexes vis-à-vis comparator countries Legal rights index Bulgaria (Sofia)

Credit Information index

Public Registry Coverage (as % of adults)

Private Bureau Coverage (as % of adults)

6

6

25.4

3

10 6.4

6 4.8

0 8.6

84.6 59.3

Czech Republic

6

5

4.2

53

Estonia

4

5

0.0

19.7

Hungary

6

5

0.0

6.9

Latvia

8

4

2.6

0.0

Lithuania

4

6

6.6

7.3

Poland

4

4

0.0

51.5

Romania

7

5

4.1

10.9

Slovakia

9

4

1.2

56

Slovenia

6

2

2.5

0

EU Best Practice (UK) OECD

Source: World Bank (2007).

Credit Information and Collateral Credit information sharing and collateral are important market supporting institutions (Djankov, 2004). A positive correlation between credit information and depth of credit markets is widely documented.

There were no private credit bureaus in Bulgaria before 2007, when Experian-Scorex Bulgarian Credit Bureau (ESBCB) was established. ESBCB works closely with the Central Credit Registry of BNB and collects and processes positive and negative credit information from financial and nonfinancial institutions such as banks, leasing companies, telecom operators, retail companies and credit card issuers. The credit bureau system is designed to provide accurate and reliable credit information on past payment behavior of borrowers (individuals and companies) and their current debt servicing status. In 2007, private bureaus covered 3 percent of the adult population in Bulgaria.

This is lower than most other countries in the region.

Real estate continues to be the preferred form of collateral, as the Enterprise Survey results shows (see Table 49), although lenders are increasingly taking movable property as collateral either. There is a general assumption that the Special Pledges Registry functions well and fees are not high. However, there are problems related to enforcement (Djankov, 2004). Enforcement of movable property takes

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several months, whereas enforcement of real property can take much more. Therefore, the Banks try to avoid resorting to the slow court system. This is extremely important since the growth in the construction sector and inward FDI in the real estate, have increased the demand for mortgages by households and the corporate sector.

Corporate Governance Strong corporate governance framework increases capital allocation efficiency within firms, helps broaden access to capital, reduces vulnerability to crisis, fosters savings provisions and renders corruption more difficult.

Analysis of corporate governance issues in Bulgaria has been conducted in 2002 by the joint World Bank-IMF program of Reports on the Observance of Standards and Codes (ROSC) (World Bank-IMF, 2002). The ROSC benchmarks the country’s observance of corporate governance against OECD Principles of Corporate Governance and is based on a template developed by the World Bank.

The 2002 ROSC concluded that Bulgaria has made substantive concrete improvements in its legal and regulatory framework, in part in preparation of accession to the EU. In particular, the report emphasized that the Bulgarian National Securities Commission, established in 1996, and subsequent amendments to both, the commercial and securities legislation, strengthened the corporate governance framework. For instance, the revisions and amendments adopted in June 2002 to the Law on Public Offering of Securities (LPOS) substantially strengthened shareholder rights for public companies, i.e. corporations whose shares may be publicly traded.

The assessment, however, recommended three additional areas of improvements in the field of minority rights of shareholders: (i) encouraging private sector organizations and business associations to prepare a corporate governance code; (ii) improving corporate governance practices in the corporate sector; and (iii) establishing an Institute of Directors that could provide training and disseminate international practices for (supervisory) boards of directors.

One particular achievement since then is the unification of the former Bulgarian National Securities Commission, the State Insurance Supervision Agency and the Insurance Supervision Agency under one single agency—the Financial Supervision Commission (FSC). The primary function of the institution, which exists since 2003, is to assist through legal, administrative and informational means for the maintenance of stability and transparency on the investment, insurance and social insurance markets. The FSC is independent from the executive authority and reports to the National Assembly of the Republic of Bulgaria. Moreover, the FSC has become an important actor in providing trainings for public authorities and private actors that cover issues related to regulation and supervision of the financial market. In addition, there have been significant legislation that has introduced corporate governance provisions that have increased transparency, governance and protection for minority shareholders in the past few years.

The FSAP review of the joint World Bank-IMF mission in 2002 concluded that the Commercial Code provides insufficient protection for minority shareholders. Problems include: shares may have disproportionate voting rights; shareholder’s meetings may be held with a quorum of as few as five percent of the capital; assets may be sold or transferred without approval of either the (supervisory) board or the shareholders’ meetings; and new capital can ignore the LPOS. As the FSAP report emphasized, these provisions are prohibited under the LPOS, but the majority of the medium and large companies, including most banks and all insurance companies and pension insurance corporations were not publicly traded and thus did not fall under the securities legislation. With the amendment of the LPOS from 2002, which came as post-FSAP intervention, a serious reform of the rules, concerning the protection of minority shareholders in public companies was made. Making certain deals, which create potential possibility for abusing the rights of minority shareholders, are now governed by special provisions (LPOS, Art. 114a, b and r).

High requirements for elected management members and detailed rules for the governing bodies’ work were introduced too (LPOS, Art.116a, b, c,). The position, Director of Communications with the investors, was created (LPOS, Art.116d) and the application of action pro socio was expanded (LPOS, Art. 118).

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In 2003, the Commercial Law (promulgated SG58/27 June 2003) witnessed significant amendment. With this amendment, the provisions of the Bulgarian Law concerning corporations and shareholders were harmonized with Directives I, II, III, VI and XII of EU Company’s law. The improvement of the rules about the governance of corporations came out as one of the vital changes of the reform. The Principles of Corporate Governance of the OECD were used as a basis for the amendments, as prescribed by the Government’s bill motivation letter 202-01-84/ 09.12.2002.

These amendments to the Commercial Law and the Law for Public Offering of Securities have ensured that corporate governance provisions for protection of minority shareholders were introduced in Bulgaria.

With the new Markets in Financial Instruments Act and the amendments in LPOS since June 2007, the harmonization of the Bulgarian legislation with the European Community Law in the field of capital markets ended. This also included the transposition of the Directive 2004/39 EEC on the markets of financial instruments, as well as the harmonization with Directive 2004/109/EU on the requirements for transparency of the information for issuers, whose securities are allowed for trading on regulated markets, and Directive 2004/25/EU on Takeover Bids.

The Global Corporate Governance Forum (GCGF), co-founded by the World Bank and the OECD advocates for high standards and practices of corporate governance in developing and transition economies. This forum brings the international community together to discuss ways of strengthening corporate governance. In the GCGF meeting in Brussels in February 2008, Bulgaria served as a benchmark case for the establishment of modern rules and norms for the good governance of public companies through the adoption of National Code for Corporate Governance.

The Bulgarian Stock Exchange adopted the Corporate Governance Code in October 2007 after variety of consultations with business associations, academic community and think tanks, also supported by the World Bank’s GCGF, who agreed on the provisions in the Code.

The Corporate Governance Code introduces the principle “comply or explain”, which means that the companies follow the Code, and in case of diversion their managements should explain the reasons for this. Information on implementing the Code should be published by the companies in their annual reports and web sites.

The Bulgarian National Code for Corporate Governance, which is based on OECD principles, constitutes standard best practice that has proven efficient over the years for the governance and oversight of public companies, as the preamble of the Code reads. It guides the public companies through five chapters (Corporate Boards, Audit and Internal Control, Protection of Shareholders’ Rights, Disclosure of Information, Corporate Governance and Stakeholders) and represents a step forward as it builds upon principles, like accountability and independence of corporate boards; the protection of shareholder’s rights; the equitable treatment of international and minority shareholders; the disclosure of information; and the integration of stakeholder interests (The Corporate Governance Code, 2007).

Currently, a Corporate Governance ROSC report is being prepared by the World Bank for Bulgaria. It studies the changes in the corporate governance framework and the impact they have created. The Upcoming FSAP for Bulgaria addresses issues of corporate governance as well.

Financial Reporting Financial discipline improved in Bulgaria after the Currency Board was introduced, due to the BNB introducing stronger banking supervision and tighter prudential rules with requirements for large credits and a phased increase of capital-adequacy requirements. Banks have been forced to develop sound practices, as the BNB’s cannot refinance banks under the terms of the currency board. This has enhanced confidence in the system and money that had been kept outside the banks in hard currency has returned. Although capital-adequacy ratios have fallen, they still stood at 13.9 percent at the end of September 2007 compared with a legal requirement of 12 percent. In addition, the ratio of non-performing loans to total loans dropped from more than 10 percent in 2000 to 2.2 percent by September 2007.

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In comparison to the banking sector, the insurance market is still underdeveloped. Prior to legal reforms in 1997, foreign involvement in the insurance market was severely limited. Currently however, there are several foreign-owned insurance firms, like Doverie JSC (main shareholders “BZP Group” JSC, “Bulstrad” JSC), “Saglasie” (main shareholders “Finance Consulting” JSC, Bulgarian Industrial Association, Chimiport JSC), and “Alliance Bulgaria” JSC (with shareholders “Alliance Bulgaria Holding” JSC and National Electric Company JSC).

By December 31, 2007 there were 79 licensed mediators that were members of the exchange.

Mutual funds started 3 to 4 years ago. By 2006, there were 40 funds, managing assets worth €150 million. Mutual funds—the main foreign collective investment schemes, offering public shares in Bulgaria, are: Pioneer Funds (Luxemburg) – distributor in Bulgaria Bulbank; Capital Invest Funds (Austria) – distributor “HVB Bank Biochim”, SGAM Fund (Luxemburg) – distributor “SG ExpressBank”, “Raiffeisen Kapitalanlage-Gesellschaft” (Austria) through Raiffeisen Bank Bulgaria, OTP International Equities Fund – UBS Fund of Funds – distributor DSK Bank (BSE-Sofia, 2008; Commission for Financial Control, 2006; Invest-Bulgaria, 2007) A ROSC report of Accounting & Auditing is expected to be completed in 2008 that will update the 2002 report. It will review Bulgaria’s auditing and accounting standards, the regulation of financial reporting, the impact of the 2003 changes in the accounting law requiring listed entities, banks, insurance companies, investment funds and pension to use International Financial Reporting Standards (IFRS) for financial reporting purposes and assess the impact of the 2005 changes in the accounting law, the extent of the requirements of the use of IFRS for all private companies and non-profits organizations, on the accounting and auditing environment. Finally, the report will look at the progress achieved of proper IFRS adoption for these companies and assess the impact of Bulgaria’s entry to the EU.

VI. Summary and Policy recommendation Bank credit to the private sector has increased significantly since 2000, reducing financing constraints for many firms in Bulgaria. Firms in the 2007 Enterprise Survey were less likely to say that access to financing was a problem than firms in surveys in earlier years and were more likely to have bank financing. Both subjective and objective data is consistent with the idea that the rapid growth in credit has reduced this constraint.

Some concerns, however, remain. One particular concern is about the stability of the expansion in credit. Although improvements in macroeconomic conditions (see Chapter 1) and EU membership have probably played an important role in reducing credit constraints, it is unclear whether other factors might have also been important. If credit growth slows in response to problems in global credit markets or to internal factors, then it is plausible that credit might become a concern in the future. Moreover, given the short-term nature of most lending, the impact could be quite rapid. The upcoming FSAP will provide vital information on the stability of lending and credit growth.

A second issue is that the terms of the many of the loans are not very attractive. Other than not wanting a loan, one of the most common reasons for not having one was that interest rates were high (14 percent of firms). Moreover, most of the loans were very short-term—over 60 percent of loans given to firms in 2007 were for less than a year and only five percent were for over 5 years.

Short-term loans are more attractive for financing short-term working capital rather than longterm investment. In addition, almost all firms used either real estate or the owner’s own assets as collateral for the loan.

A final issue is that access remains more problematic for SMEs than for larger firms. Although credit has growth across the board, small and medium-sized enterprises were less likely to have a loan than large enterprises and were slightly more likely to be rejected. Given the importance of land as collateral, it is not surprising that firms with land were more likely to have loans than firms without. Moreover, the comparatively high collateral (median value of the collateral stood at 128 percent of the loan amount in Bulgaria, 2007 Enterprise Survey) might prevent SMEs from getting access to sufficient credit. These suggest that access to finance might be a problem to SMEs and entrepreneurs, in general, that do not own their own land—consistent with the firms that owned their own land were more likely to have loans than firms without. Recommendations to improve access to credit for firms include the following.

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Further analysis is needed to understand why bank spreads are high and access to longterm loans is low. Further analysis is needed to study why bank spreads in Bulgaria are so high compared to the comparator economies and also why long-term loans are rare. As noted earlier, about 60 percent of the firms responded that they have loans for one-year or less and only 5 percent had loans for more than five years.

Improve access to credit for SMEs. The SMEs represent a majority of the firms in the Bulgarian economy and thus, improvement of conditions for access to credit for SMEs would benefit their investment and growth, thus adding value to the local economy. Further analysis on the problems for access to credit for SMEs is needed to identify the existing barriers.

Increase credit bureau coverage. Credit registries can expand access to credit for the corporate sector by collecting and distributing information on whether borrowers are credit worthy as lenders could more easily assess the risk associated with a new loan. Therefore, improving the coverage of the credit bureau, which is currently too low (3 percent of the adult population), is of high importance for lenders to assess more efficient the profile of the borrowers and the associated risk.

Improve understanding of why other types of collateral, like machinery and receivables, are not used. Given the expanded use of real property as collateral in borrowing activity, and to a certain extent, movable property, and the authorities might consider how to promote the use of other types of collateral (i.e., machinery, receivables, etc.).

Analyze reasons for high collateral requirements. The median amount of collateral required for the loan was equal to about 130 percent of the loan, with most amounts between about 100 and 150 percent of the loan value. The authorities can consider analyzing why the collateral is so high.

Better understand the role of leasing companies and consumer credit companies and how to regulate them. Credit from the non-banking financial intermediaries has grown spectacularly in recent years. Leasing companies and consumer credit companies have proliferated. These are, in general, less supervised, and a more in-depth study is needed to propose whether they might require more supervision.

Encourage capital market development. The underdeveloped capital market in Bulgaria, which does not attract solid foreign investors despite the entry of Bulgaria to the EU market, limits opportunities for local firms to draw investment funds through securities. The capital market could either attract solid foreign investors or it will be threatened to loose local pension and insurance funds which will start to be more active abroad, searching for better capital markets.

Consider recommendations from relevant in-depth studies. The government authorities are encouraged to consider implementing the relevant recommendations that will be provided by the updates of the FSAP, Accounting & Auditing ROSC, Corporate Governance ROSC, available in the autumn of 2008, and the Review of Consumer Protection in Financial Services, available in early 2009.

Conduct Insolvency and Creditor Rights Systems ROSC. The Government authorities may consider conduct of Insolvency and Creditor Rights Systems ROSC. This is a report, which reviews the legal and regulatory frameworks for creditor rights and corporate insolvency systems, based on World Bank Principles and Guidelines for effective insolvency and creditor rights systems adopted by the World Bank in April 2001. The World Bank principles contain 35 principles that are divided into four major categories: i) legal framework for granting and enforcing security (creditor rights, enforcement and collateral systems); ii) The legal framework for insolvency; iii) Credit risk management and the environment for corporate workouts and restructurings; and iv) implementation framework (i.e., implementation by the courts, and regulatory oversight of practitioners).

Summary matrix for all Policy recommendations ISSUE

SHORT-TERM RECOMMENDATION

MEDIUM-TERM RECOMMENDATION

INNOVATION & TECHNOLOGY ABSORPTION

National Innovation System

Research, Innovation and technology policy is fragmented in terms of coordinating structures and strategies. This creates programs with overlapping objectives, partial coherence and a poor rationalization of resources.

Develop a single integrated national strategy on innovation and research and maintain an annual evaluation of the national innovation system.

Unified structure on innovation and research can be established through the creation of a single consultative council, representing government, research and industry at high institutional level.

Innovation & technology absorption activities

Low R&D spending, close to 0.5 % of GDP, thus far away from the EU’s Lisbon Agenda, which targets 3 % of GDP spending on R&D by 2010.

Reach consensus between government, industry and research for the increase of public/ private R&D spending.

Increase public R&D and expand measures that stimulate R&D in the private sector.

The share of R&D noncompetitive funding is high and it is not based on strategic plans or performance indicators.

Develop an action plan for decrease of non-competitive funding to be based on the following practice: Institutional or “discretionary” research funding to research institutes and universities to be based on agreed strategic plans in line with national research priorities and based on clear performance metrics.

Multi-year funding commitments could be introduced to allow for research institutes and universities to be more strategic in their planning.

Institutional funding may not only be conditional on prior performance but also on periodic independent evaluations of the recipient institutions.

R&D and innovation funding to the private sector needs to be efficient and not delayed

The NIF funding may increase in terms of number of grants.

Independent evaluation of NIF is needed following the NSF model of evaluation.

There is unused potential for closing the productivity gap through technology absorption.

Provide consultancy or training services to help domestic firms understand and negotiate technology licensing agreements.

Innovation & Technology absorption in firms

Duplication between NIF and NSF funding needs to be avoided.

Create a network of technology extension centers focused on transferring productivity-enhancing hard and soft technologies to Bulgarian firms; it should not be built from the ground up Provide “soft” technolbut should leverage techniogy upgrading technical cal resources from existing assistance and training universities and research programs focusing on institutes in Bulgaria. quality and organization- Create schemes with a comal processes that impact bination of matching grants technology absorption. and loans for technologyintensive manufacturing equipment for SMEs. Introduce supplier development programs that help potential domestic suppliers to position themselves in global value chains in which they can benefit from knowledge and technology transfer from buyers.

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ISSUE

SHORT-TERM RECOMMENDATION

MEDIUM-TERM RECOMMENDATION

INNOVATION & TECHNOLOGY ABSORPTION

Adoption of foreign technology

Soft and Hard infrastructure for innovation and knowledge transfer

There is a gap in early Seed funding for early-stage stage technology commer- start-ups can be provided. cialization and pre-competitive research funding. The government can encourage the creation of business angel network.

The government may consider introducing measures to increase the scale and quality of its R&D workforce.

The Government can facilitate the creation of a privatelymanaged venture capital fund, through leveraged investments or other instruments.

The IPR enforcement status quo discourages domestic innovation and transfer of technology by foreign investment.

Strengthen the IPR enforcement regime through capacity building and better coordination of enforcement agencies.

The link between university, industry and research institute is not stable

Devise a National Program for strengthening the link between university, industry and research institute.

Quality upgrading programs from the government would allow firms to position themselves in global value chains in which they can benefit from knowledge and technology transfer from buyers.

Scale up financial support for industry-research collaboration to increase linkages in the national innovation system.

Increase support for R&D research institutes when they collaborate with industry.

Provide incentives to strengthen the research capabilities of Universities.

The government can change its legislation to allow that universities accommodate incubators and technoparks.

QUALITY INFRASTRUCTURE

Conformity assessment

The market for Consider privatizing the certification and testing Executive Agency for Testing is now mature in Bulgaria and Certification. and no longer requires provision of conformity assessment services by the state.

There is lack of capacity of Training and consultancy serNotified Bodies. vices for Notified Bodies need to be provided by the government .

There is a need for International certification to be integrated in a wider scheme that would assess quality improvement in firms.

Accreditation

Support for quality management system certification in Bulgarian firms could be integrated as part of wider schemes that are evaluated against actual quality improvement in firms, not just the firm’s ability to meet the requirement of the standard.

Two independent quality assurance systems for conformity assessment bodies exist which creates redundancies.

Consolidation of the accreditation system with the Notified Body designation system can be considered.

EA Bulgarian Accreditation Service is ineffective and finds it difficult to adapt to the market conditions. It does not have private sector representatives in its governance bodies and it is not autonomous.

The government could consider privatizing EA Bulgarian Accreditation Service if it is unable to provide it with more private sector representation and autonomy under its current legal status.

Summary matrix for Policy recommendations

ISSUE

SHORT-TERM RECOMMENDATION

157

MEDIUM-TERM RECOMMENDATION

QUALITY INFRASTRUCTURE

Accreditation

Metrology

The Executive Director of EA BAS is a political nominee and has the discretion to appoint technical personnel.

EA BAS technical personnel should be selected with the oversight of a technical council and could not be the discretionary responsibility of a public sector nominee.

Accreditation delivery times are time consuming.

Accreditation delivery times could be shortened to make accreditation more appealing to the private sector.

The market for certification body accreditation is underdeveloped.

EA Bulgarian Accreditation Service could invest in this area with the help of the government.

Proficiency testing programs are very expensive and require a high level of technical expertise, which is not available for enterprises.

The government could provide support for proficiency testing programs.

Bulgaria is not fully recognized by international organizations in the accreditation sphere

Bulgaria needs to seek full membership in ILAC and IAF Bulgaria needs to ensure that it becomes a full signatory to all areas of EAMLA

Bulgarian Institute of Metrology (BIM) provides just few services to commercial calibration laboratories and it is primarily concentrated on services for the secondary market.

BIM could formulate a strategy for its transition from the secondary calibration market to the primary calibration market.

BIM provides limited technical and scientific expertise to promote the absorption of good practices and innovation in industry.

BIM’s regulations could provide incentives for the provision of training and consultancy services.

BIM has limited autonomy.

BIM could be provided with more autonomy in order to become more responsive to market needs and bring its operating structure in line with European “best practice”.

The Legal Metrology is divided between SAMTS and BIM and this distorts efficiency for the service.

The government may consider transferring all legal metrology functions (including enforcement) to BIM, given its existing technical expertise in scientific metrology.

The government has not invested much in the Scientific Metrology Facilities.

The government could invest in facilities that are suited for the activities of a national metrology institute and do not compromise the effectiveness of BIM’s operation.

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ISSUE

SHORT-TERM RECOMMENDATION

MEDIUM-TERM RECOMMENDATION

QUALITY INFRASTRUCTURE

Standardization

Bulgaria has a large stock of obsolete national standards.

There is limited English training to conformity assessment personnel.

BIS needs to increase efforts to systematically review its national standards to reduce its outsized standard stock.

Bulgaria needs to continue adopting European and international standards but may ensure that there are effective processes to translate them into Bulgarian and to provide English training to conformity assessment personnel.

There is limited participation of the private sector in European and international standardization activities.

The government needs to support participation of the private sector in European and international standardization activities.

REGULATION & TAXATION Entry

Improper practice of central authorities, and primarily municipalities of registration and licensing regimes.

LARACEA needs a full assessment of its implementation to explore the gaps in the law and track the improper practice by municipalities and central authorities.

The Assessment could identify the package of special administrative acts that have to be amended so that the law functions, as its spirit prescribes.

The LARACEA needs to be amended in order to address better its implementation.

Regulatory regimes at the municipality level that do not comply with the law need to be abolished. Regulatory Impact Assessment national system is necessary to be put in place, which will monitor the implementation of regulatory regimes by both, the central executive power and the municipality authorities.

Municipality registration procedure is cumbersome, lengthy and superfluous.

The Municipality registration needs to be abolished or replaced by a simple notification obligation.

The Better Regulation Unit at the Council of Ministers can monitor the implementation of this reform in consultation with Business Associations and the National Association of Municipalities in the Republic of Bulgaria.

Fees to register a business are excessive.

On-line registrations at the Trade Registry should be promoted by the government.

A special methodology for the classification of the tariffs for the central administrative service fees could be developed. A strategic policy document that will embrace the administrative practice and provide an instrument for classification of the tariffs for the central administration service fees could target universal reduction of the administrative cost for businesses.

Reduce the overall administrative cost for the business to be competitive in respect to other new EU entrants.

Summary matrix for Policy recommendations

159

ISSUE

SHORT-TERM RECOMMENDATION

MEDIUM-TERM RECOMMENDATION

The steps and the time to complete the registration procedures are high.

Requirements for preregistration at the Trade Registry could be discussed with the business until an effective strategy is devised.

Streamline the effective use of the Trade Registry and the single ID for firms to improve business registration.

REGULATION & TAXATION Entry

Licensing

The Trade Registry is Capacity building of currently not functhe Trade Registry and tioning well. adequate staffing are crucial elements for the institutional set-up of the national registration system.

Additional resources are required to be channeled to improve capacity building of the Trade Registry so it improves its functioning in serving the business.

Duplication of regulatory regimes at the central and at the local level are currently in place as well as submission of identical documents by firms.

Review the administration procedures and improve coordination among central and local authorities.

Streamline the registration procedures for firms through the functioning of the Administrative Regime and the establishment of on-line monitoring system, as a supporting tool to avoid improper application of regulatory regimes.

Close consultation with business associations and the National Association of Municipalities in the Republic of Bulgaria is needed.

The firms find it difficult to obtain import licenses and especially operating licenses. Duplication of documents, already submitted, is a practice.

Streamline the procedure to obtain import licenses. Establish sectoral electronic public registry (where such are not established yet) which can publish the licensees, the validity of the licenses and the terminated licensees.

Set up the Administrative Registry.

Effective functioning of the Administrative Registry.

Problems with small businesses in obtaining import licenses and operational licenses frequently occur.

The Ministry of Economy and Energy has to specifically consider the barriers for small firms in the application process for licenses.

Streamline the process for obtaining import and operational licenses by small firms.

Existing procedures in licensing and inspection of food producers and traders of food of animal and non-animal origin are burdensome for the business.

Review existing procedures and improve coordination among municipalities, the Ministry of Health and the Ministry of Agriculture and Food.

Establish a functioning Food Safety Authority, which would replace the old system of licensing and inspection of food-processing firms and food trade industry and close the circle from the “field to the table�.

Post-licensing inspections are missing for both, licenses that are issued for five years and licenses that are issued for indefinite period.

Risk-based inspections at the municipality level in the post-licensing period could be introduced. They could result in more efficient inspections, instead of central authorities

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ISSUE

SHORT-TERM RECOMMENDATION

MEDIUM-TERM RECOMMENDATION

Review licensing regimes in specific dynamically developing sectors with the option to be outsourced to business associations.

The classification system can be abolished and transformed into simple registration. The inspection service can be performed by the local municipality, whereas the registration can be outsourced to a tourism business association.

REGULATION & TAXATION Licensing

The classification system (type of licensing) in the tourism sector is burdensome

Outsource licensing regimes in dynamically developing sectors to business associations.

Inspection and Certification

Exit

Capacity building for public and municipal authorities in implementation of regulatory regimes is needed.

Identification of key municipalities and central authorities where capacity building is needed.

Self-regulation of tourism activities is limited.

Transfer the mandate for regulation of the sector from the State Tourism Agency to sector associations, who can conduct rating and develop quality standards.

The efficiency of inspections in the food processing and food trade industry is unsatisfactory.

Evaluate the efficiency of inspections and consider centralizing the inspection authority for foodstuffs.

Training for public and municipal authorities and technical capacity building on how to apply and maintain effectively regulatory regimes, the execution of procedures and inspection regimes.

Random risk-based inspections in the food sector are uncommon.

Risk-based inspections can dominate the inspection system but they could be also linked to a provision of sanctions for violations that are enforceable and that carry additional inspections in the future.

Inspection fees for laboratory testing in the food sector are excessive.

Introduce a schedule with three categories based on the size of the inspected lot.

Enterprises are not encouraged to acquire voluntary certification for the conduct of their business operation which raises consumer confidence in the quality of the product.

Devise a scheme of incentives for firms that obtain voluntary certification for business activities.

Timing for court proceedings is excessive and cost for exit is high.

In-depth analysis of the recent changes in the Commercial Act, addressing exit of business is needed

The trustee’s performance in bankruptcy procedures is not motivated well enough.

The remuneration for the bankruptcy trustee might be linked to the proceeds realized from cashed assets.

Public access to auctions that sell assets after bankruptcy is limited.

Establish Internet portals by District Courts to post court decisions and announce asset sales in cases when the state is not involved as a creditor for public receivables. Use the example of the State Receivables Collection Agency.

The process of documentation for investigation, listing and verification of debtor’s assets should be speeded up, which would decrease timing for court proceedings and costs for exit.

Summary matrix for Policy recommendations

ISSUE

161

SHORT-TERM RECOMMENDATION

MEDIUM-TERM RECOMMENDATION

Industrial zones are still not promoted well as targets for inward FDI which links to local SMEs.

The Ministry of Economy and Energy could develop an Action Plan that would link industrial zones, export potential of the country and the link between inward FDI and local SMEs.

Promote industrial zones through incentive schemes that would encourage inward FDI to settle and link with local SMEs.

The timing of the issuance of construction permits and local infrastructure is hurdled by the procedure related to the Detailed Development Plans (See Law for Spatial Planning).

Amendment in the Law for Spatial Planning, targeting improvement of the procedure for Detailed Development Plan needs to be introduced.

Regularly monitor the system of creation of detailed development plans at the municipality level.

REGULATION & TAXATION Access to Land

Urban Planning at the Black Sea coast is problematic.

Courts and Crime

The Ministry of Regional Development and Public Works, which is now dealing with Urban Planning, could consider preparing “best practice” technical designs, introduce market-based fees for consultants, and comply with longterm strategy for tourism and sustainable development.

Long time delays and high costs for the issuance of construction permits are cumbersome for the business. Long delays are observed in the issuance of permissions for exploitation of buildings either

Preparation of in-depth diagnostic on problems with issuance of permission for exploitation of the buildings seems highly necessary.

The procedures and transparency for the issuance of construction permit are not publicized and not monitored.

The municipalities can improve access to the procedures for issuance of construction permits by publishing on their website full information (the Sofia municipality can be a benchmarking case).

The Expert Council for the issuance of construction permits can be outsourced to the private sector.

A limit for the cost of construction permit per square meter should be introduced based on economic analysis.

On-line system that would track the accomplishment of each step in the process of application for construction permit could be introduced at the municipality level.

Municipality administration units, dealing with issuance of construction permits, are understaffed and efficiency is low.

The staff has to be adequate to the demand.

A system that tracks performance of each administrator (time to administer number of applications) can improve the efficiency for the issuance of construction permits.

Enforcement of contracts depend a lot on the duration of trial and judgments, which are slow.

Introduction of monitoring system to track the duration of trial and judgments for enforcing contracts.

Enforcement of contracts’ cost is high, which is an incentive for the firms to breach contracts.

Introduce a system of more effective and less costly enforcement of contracts.

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ISSUE

SHORT-TERM RECOMMENDATION

MEDIUM-TERM RECOMMENDATION

REGULATION & TAXATION Courts and Crime

Street crime costs for the business are high.

Introduce a monitoring system of how effective the fight against street crime is.

Taxation

Firms engage in informal practice due to the high rate of social security contribution payments.

Reduce the social security contribution payments but in a fiscally sustainable manner.

Business time for tax payments is high.

Review the reporting requirements of the National Revenue Agency.

Clear guidelines and terms for delivery of public services are missing in the tax administration.

Guidelines and terms of Regular monitoring for cordelivery of public serrupt practices could be esvices for the tax adminis- tablished. tration can be developed.

The permission regime by the National Revenue Agency for the avoidance of double taxation is burdensome for the business.

Simplification of the permission regime for double taxation by turning to the European practice.

Improving worker education and skills is improving both the quality of education and the links between education and employment.

Complete the on-going process of modernizing the primary, secondary, and tertiary school system, including vocational education and training, as suggested by recent World Bank studies.

Worker skills are ranked as one of the major concerns among firms, particularly valid for innovative firms and firms in the IT sector.

Government strategy could look closely at worker skills improvement for innovative and IT firms.

There is shortage of skilled workers and high level of inactivity among people with only basic education. There is low unemployment rate among highly educated workers.

Promotion of tertiary education and second chance education programs and encouragement of adults to finish their secondary education is important.

Small firm managers provide little training.

Further research is needed in the field of providing a better understanding of why firms do not provide training.

LABOR MARKETS Worker skills and training

Improving the market relevance of degree programs and increasing the output of tertiary science and engineering graduates would be worth considering.

Pilot, test and monitor various approaches to promoting adult training.

Summary matrix for Policy recommendations

ISSUE

SHORT-TERM RECOMMENDATION

163

MEDIUM-TERM RECOMMENDATION

LABOR MARKETS Firms’ incentives to train The collective agreements workers are in general can include a clause which low. provisions trainings for workers but also restitution for employers if the employee leaves the job. This needs to be further discussed among government, employers’ and employees’ associations.

Methods relying on financial incentives include: i) payroll levies that firms can reclaim if they invest in training their workers; ii) tax incentives for firm-level training; and iii) matching grants that provide funds to offset the cost of training. Apart from this, public-private partnerships might be encouraged to provide funding for training.

Matching funds to NGOs managing projects from the OPs of the EU structural funds that target LLL activities can be provided.

Life-long learning

Skill-intensive industries The government has taken require more workers steps for encouraging those who have not completed secondary education to attend literacy courses, managed by the Employment Agency, and lower minimum entry requirements to allow these graduates to enter vocational training. These programs have to continue operation.

Specifically designed training for people over 50 might improve the qual ity of the aging working force.

Labor regulation

Bulgaria witnesses a dominance of labor contracts as temporary and part-time workers are hired by very few firms.

Consider measures to increase flexibility with respect to working hours and part-time work within the framework of consultation with the social partners.

Consider reducing nonwage labor costs such as social security payments and payroll taxes.

Roma minority

10 Specialized Labor offices for the Roma minority, which suffers from high unemployment rates, needs evaluation.

The specialized labor offices need annual monitoring in order to assess their effectiveness.

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ISSUE

SHORT-TERM RECOMMENDATION

MEDIUM-TERM RECOMMENDATION

ACCESS TO FINANCE Investment finance

Financial System indicators

Financial Institutional structure

Access to finance for Analysis on the access small-and-medium- to credit for SMEs is sized firms is limited. needed to identify the barriers.

The government authorities may consider implementing relevant recommendations, to be provided by the updates of FSAP, Corporate Governance ROSC and Accounting & Auditing ROSC in late 2008.

There is expanded use of real property and to a certain extent movable property as collateral and not so much other types of collateral (i.e., machinery, receivables, etc.).

The authorities could consider how to promote the use of other type of collateral, besides real property and movable property.

Bank spreads in Bulgaria are high vis-Ă -vis comparator economies and also long-term loans are rare.

The phenomena of maintained high bank spreads and small percentage of long-term loans needs to be further studied.

The government authorities may consider implementing relevant recommendations, to be provided by the updates of FSAP in late 2008.

The median amount of collateral required for the loan (as per 2007 Enterprise Survey) was equal to about 130 percent of the loan, with most amounts between about 100 and 150 percent of the loan value, which is high.

The authorities can consider analyzing why the collateral takes so high percentage of the loan value.

The government authorities may consider conduct of Insolvency and Creditor Rights Systems ROSC to review the legal and regulatory frameworks.

The Coverage of the The authorities need to private credit bureau promote better coverage is low (3 % of adults). of the credit bureau.

The government authorities are encouraged to consider implementing relevant recommendations to be provided by the Review on Consumer Protection in Financial Services in early 2009.

Credit from the nonbanking financial intermediaries has grown spectacularly in recent years. Leasing companies and consumer credit companies have proliferated.

The government authorities are encouraged to consider implementing relevant recommendations to be provided by the Review on Consumer Protection in Financial Services in early 2009 and updates of FSAP in late 2008.

The capital market is under developed and it provides limited opportunities for local firms to draw investment funds through securities.

The leasing companies and consumer credit companies are, in general, less supervised, and more in-depth study is needed to propose whether they might require regulation.

The capital market could either attract solid foreign investors or it will be threatened to loose local pension and insurance funds which will start to be more active abroad in search for better capital markets

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Endnotes 1

European Bank for Reconstruction and Development (2003); World Bank (2008c)

2 According to data from the Bulgarian National Bank, it reached an average annual rate of 12.6 percent in 2007, before increasing to over 15 percent at an annual rate by June 2008.

3

Data for 2007 is from Eurostat website.

4 The 2007 data is taken from the Bulgarian National Bank. The difference between gross fixed capital formation (GFCF) and gross capital formation (GCF) is due to differences in treatment of inventories. Inventories increased significantly in 2006 leading to a significant increase in the difference between the two measures.

5 In 2006, the unemployment rate was slightly lower than the EU 27 average and less than that of Germany (10.3 percent), France (9.1 percent), Poland (13.8 percent) and Slovakia (13.4 percent). In 2007, this rate is expected to be almost equal to its level for EU 27, or below it. It has also to be taken into account that the sharp decrease of the unemployed is boosted by the demographic factor in addition to the recent employers’ demand multiplying (Eurostat, 2008).

6 Still, the National Statistical Institute does not hold households’ community panel surveys and there is no adequate information about flows according to the employment status to indicate the changes more precisely.

7

See International Monetary Fund (2007b)

8 For example, Lipsey (2001) shows that FDI inflows were far more stable during three recent currency crises than other investment flows. Loungani and Razin (2001) note, however, that although FDI inflows appear to be more stable than other capital inflows, that it is possible to effectively reverse flows. They note “though it is true that the machines are ‘bolted down’ and, hence, difficult to move out of the host country on short notice, financial transactions can sometimes accomplish a reversal of FDI. For instance, the foreign subsidiary can borrow against its collateral domestically and then lend the money back to the parent company. Likewise, because a significant portion of FDI is intercompany debt, the parent company can quickly recall it.”

9

See International Monetary Fund (2007b).

10 For example, International Monetary Fund (2007a) argues that ‘prudent fiscal and incomes policies need to be upheld to preserve the sustainability of the currency board, notwithstanding popular sentiments that present budget surpluses are excess and that the public purse string should be loosened to address high social expectations following EU accession.’

11 The survey was carried out between April 1 and April 15 in 2007. One thousand randomly selected (employed, self-employed, managers, unemployed, pensioners, others) persons over the age of 18 years living in different-size settlements (capital city, district town, town and village) were interviewed. The interviews were face-to-face according to a preliminary designed questionnaire. The survey was not nationally representative.

12 The survey was carried out in May 2006 by the National Social Security Institute. The cluster sample methodology is used and the regional factors and the distribution of respondents by districts, towns and villages – 9 respondents and up to 9 substitutes in a cluster. The sample is made on the basis of the personal register of the NSSI. The Report on the Survey was published on the home page of the National Insurance Institute http://www.noi.bg.

13 The household survey includes soldiers and police and people under civil contracts, while the enterprise survey does not.

14 This question was not asked in the 2005 BEEPS survey and so comparisons are not possible with the other new EU entrants.

15 Although microenterprises were less likely to say that they competed less with informal firms than other firms, the difference is small and appears to be due to sampling variation. In particular, a ttest that the means are equal for micro and non-micro enterprises cannot reject the null hypothesis that the two means are equal (p-value=0.29).

16 See the Sampling Note for a technical justification of the minimum number per stratum (http:// www.enterprisesurveys.org/Methodology).

17 In particular, because technical efficiency is calculated in a regression framework, poor measurement of capital can lead to attenuation bias and hence biased estimates of productivity.

18 For example, many studies have found that poor infrastructure explains the poor performance of firms in Africa (Biggs and others, 1996; Eifert and others, forthcoming).

19 The National Innovation Strategy was adopted by the Council of Ministers on August 8, 2005, Decision No.723 (amended with decision No.385 from 22 May 2006).

20

Two examples are biotechnology and materials sciences.

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21 The EU27 includes Belgium, Bulgaria, the Czech Republic, Denmark, Germany, Estonia, Ireland, Greece, Spain, France, Italy, Cyprus, Latvia, Lithuania, Luxembourg, Hungary, Malta, the Netherlands, Austria, Poland, Portugal, Romania, Slovenia, Slovakia, Finland, Sweden and the United Kingdom.

22

Eurostat

23

Cohen, Nelson and Walsh (2000)

24

Cohen and Levinthal (1990)

25

Eurostat

26

UNESCO Science & Technology Statistics

27 Different industrial sectors are characterized by different rates of global technological progress and thus different rates of technology renewal at the firm level. Hence, it would not be very informative to compare aggregate levels of technology acquisition across countries, since each country is likely to be associated with a different industrial profile. For example, one would expect firms in the electronics industry, where product cycles are very short and there is constant R&D in process technologies, to invest in new manufacturing equipment more frequently than firms in the basic metals industry, a slower moving sector.

28 Standards are another important form of foreign technology adoption and are discussed in Chapter 4.

29

Bulgarian National Bank data

30

See, for example, Easterly’s (2008)discussion of the garment industry in Bangladesh

31 Business angels are wealthy private investors who take equity stakes in small, high-risk firms and typically provide them with advice and contacts.

32

One module of the NSF targets thematic priorities.

33

Structural Funds allocated to Bulgaria during the 2007-2013 period will total €6,853 billion.

34 Includes Priority Axis 1, Objectives 1 and 3 of Priority Axis 2. Priority Axis 3 of the OP also includes €200 million for financial instrument for SMEs, some of which could fund innovation-related activities.

35 This represents an increase in the 6 percent of total EU Structural Funds targeted to research and innovation between 2000 and 2006.

36

Business Software Alliance (2006).

37

European Commission (2006a; 2006b).

38

Based on 2005 data from BAS and UNESCO Science & Technology statistics.

39 reports.

Based on data from the Max Planck Society and Fraunhofer-Gesellschaft 2006 annual

40 Also referred to as research and technology institutes (RTIs) or research and technology organizations (RTOs).

41 See Arnold and others (1998). International surveys show that IRDI can provide a broad range of innovation-related activities, spanning from research, to experimental development, design and applications engineering, technical services, standards and certification and technology diffusion.

42

“Programa Calidad Integral y Modernizació.

43

Such as ISO 9001 and the European Foundation for Quality Management (EFQM) schemes.

44 See Lee and others (2007), Shetty and Buehler (1985), Garry (1985), Barrett (1994), Hart and Hart (1989), Sumanth and Arora (1992), Westlund and Löthgren (2001), Escribano and Guasch (2005; 2005).

45 This occurs when the contents of the standards cover technological areas in which a limited number of firms have property rights, exclusive knowledge or the exclusive resources to utilize a technology.

46 Notified Bodies are conformity assessment bodies that are authorized to issue the ‘CE marking’ on products subject to relevant EU legislation, and thus ensure their free circulation within the EU. 47

Includes 2004 and 2007 EU accession countries.

48 The quality of certification services is largely dependent on the quality of its auditing staff.

The IRCA is the largest international certification body for auditors of management systems. IRCA standards are high and its certification instills confidence in an auditor’s qualifications.

49 The Bulgarian Accreditation Service (EA BAS) accredits organizations according to the most widely used and recognized European and international standards. ISO/IEC 17025, ISO/IEC 17020, ISO/IEC 17021, EN 45012, EN 45011, ISO/IEC 17024, Guide 66.

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50 These bodies are said to deliver certificates in as little as a week, while it usually takes a few months to conduct a proper audit and register a company.

51 The IAF Guidance on Cross Frontier Accreditation (International Accreditation Forum, 2002) allows accreditation bodies to reduce the frequency of surveillance visits in the absence of justifiable complaints, under certain conditions.

52

Also referred to as Accreditation Board.

53 The sole non-advisory role of the Accreditation Council is to nominate members of Objections Committees, with powers to reverse the Executive Directors decisions in regards to suspending, refusing or withdrawing an accreditation. However, the powers of the Accreditation Board are limited by the fact that of the three members of the Objections Committee, one must be an employee of EA BAS, hired by the Executive Director, and one must be a member of a technical committee approved by the Executive Director.

54 Decree No 375, dated 29 December 2006, For Adoption of Structural Regulations of Executive Agency “Bulgarian Accreditation Service”.

55 EA is a signatory of the IAF MLA and the ILAC MRA, and as a result, such signatories are automatically recognized by all IAF and ILAC MRA members.

56

EA will decide on Bulgaria’s extension to additional areas of the EA-MLA in 2008.

57 In the most advanced NMIs, it is common for all standards other than the kilogram to be primary standards, while in many other countries with less mature scientific capabilities, NMIs use secondary standards because they are much less costly and are sufficient to satisfy the measurement accuracy requirements of the domestic industry.

58 This includes all the relevant quality management elements of ISO 9001 and addresses other technical elements relevant to testing and calibration laboratories, such as staff competence, test method validation, and uncertainty of measurements reference materials.

59 The recognition of national measurements by signatories of the CIPM MRA relies on a database of ‘Key Comparisons’ of national measurement standards, based on participation in international and regional inter-laboratory comparisons.

60

Directive 90/384/EEC.

61 Also referred to as the National Standardization Act, published in State Gazette No. 88/04.11.2005 effective 05.05.2006.

62 Hausmann and Velasco (2005) illustrate this point with an analogy to camel and hippos. They note that the few animals that you find in the Sahara will be camels, which have adapted to life in the desert, rather than hippos, which depend heavily upon water. Asking the camels about problems associated with life in the desert might not adequately represent the views of the missing hippos.

63 This appears to be true for both sensitive and less sensitive questions. Jensen et al (2008) show that non-response patterns and lying reduce measured corruption in politically repressive environments.

But similar patterns also appear for less sensitive questions. In particular, Clarke et al (2006) show that firms appear to complain more about access to finance in countries that are more free politically than in other countries after controlling for other country and firm characteristics.

64 See, for example, Gelb et al (2006) for work using data from Africa or Hellman and others (1999) for work using data from Eastern Europe and Central Asia.

65 When this variable is added to the regressions, the coefficient is positive and statistically significant and the results indicate firms that say regulations are enforced unpredictably were almost 25 percentage points more likely to say that political instability was a problem than other firms were.

Although there might be some element of some firm managers complaining more than others, it is important to note that (i) this variable is not significantly correlated with most non-regulatory variables (e.g., electricity, telecommunications, land or finance); and (ii) although, not surprisingly, it is correlated with most of the regulatory variables and variables related to regulation such as taxation, corruption, and courts, it is more strongly correlated with political instability than with any of these other variables (both regulatory and non-regulatory) in terms of both magnitude and statistical significance.

66 The difference is statistically significant even after controlling for other factors that might affect perceptions (see Econometric Appendix).

67 The difference is not statistically significant after controlling for other factors (see Econometric Appendix).

68

See Gelb and others (2006).

69 The question on tax compliance is asked in a way that managers can answer without necessarily implicating themselves. Rather than asking them about their level of compliance, a broader question about ‘firms like yours’ is asked. The question is phrased as ‘it is said that many business establishments face difficulties when fully complying with taxes and regulations, what percent of total annual revenue would you estimate the typical firm in this establishment’s line of business reports for tax purposes. The reasons for this approach are discussed in greater detail in Iarossi (2006).

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70

See, for example, Clarke and others (2007) for a discussion of South Africa.

71

See Reichel, Motta and Evgeniev (2007).

72 The first (1999) BEEPS survey was part of the World Business Environment Survey (WBES), which is discussed in detail in Batra and Stone (2002). The survey methodology is also discussed in European Bank for Reconstruction and Development (European Bank for Reconstruction and Development, 1999). Synovate (2002; 2005) discusses the BEEPS survey methodology in the two later surveys.

73 For example, the earlier surveys asked about ‘cost of finance’ and ‘access to finance’ separately, while the 2007 survey asked only about ‘access to finance (availability and cost)’. Other examples include that the first BEEPS (1999) survey asked about ‘infrastructure’ rather than ‘electricity, telecommunications, and transportation’ separately, the 2004 Enterprise Survey did not ask about corruption and that all other surveys asked about a long list of regulatory constraints.

74 Different lists of constraints are probably particularly troublesome when the questions are phrased as “what are the biggest constraints you face”. Even when ‘other’ is offered as a potential answer, firm managers appear to usually choose a constraint from the list.

75 Iarossi (2006, p. 61-62) discusses the design of these questions in the context of business environment surveys.

76

Porter and others (2007) describe the sampling methodology.

77

See, for example, the description in Lopez-Claros and others (2006, p 214-215).

78 Using firm-level census data from OECD countries, Bartelsman and others (2004) show the process of creative destruction affects productivity directly, by reallocating resources towards more productive uses, but also indirectly through the effects of increased market contestability.

79 The Limiting Administrative Regulation and Control on Economic Activities Act came into force on 18 December 2003 (SG. 55 from 17 June 2003, last amendment SG.16, 15 Febr.2008). Since 2003, the law witnessed several amendments, one of the last ones being incorporated in art.3, par.4., which reads during preparation of the bill, which foresee the introduction of licensing or registration regime, the public body, which proposed its insertion into the legislative program of the Council of Ministers or which is responsible for its preparation, prepares a motivated statement for the necessity of this regulation and its capabilities to meet the goal of the law which is facilitation and encouragement of business activities by restricting administrative regulation and administrative control by central authorities or local self-governance (Art.1, par.2).

80 Governments improve effectiveness, efficiency and transparency of regulations in order to minimize the negative impacts of businesses and maximize public interests. In this light, Regulatory Impact Assessments (RIAs) or Impact Assessments (IAs) embrace a range of methods “aimed at systematically assessing the negative and positive impacts of proposed and existing regulations. RIAs are the general trend of EU member states for regulatory management and improving regulatory powers of governments (Organization for Economic Co-operation and Development, 1997).

81

Jacobs (2007).

82 The Council for Economic Policy (CEP) is the highest consultative body of the Bulgarian Government, which approves national strategic documents, state loans, among others.

83 On 17 March 2008, the Council of Ministers, under the chairmanship of Prime Minister Stanishev, publicly discussed the Better Regulation Program 2008-2010 with the national business associations, think tanks and the World Bank. After a consultation process, the program was adopted (available at www.strategy.bg). It provisions the removal and reduction of certain number of administrative regimes; creation of an institutional structure for the application and control of Better Regulation Policy; acceleration of the dialogue with interested parties; and regulatory improvement at the municipal level. The program has a total of 22 measures, terms and responsible actors, involving CoM, line ministries, public agencies and the National Association of Municipalities in the Republic of Bulgaria.

84 Other obstacles, such as telecommunications and zoning restrictions are only asked to retail trade and IT firms.

85 See Friedman and others (2000), Djankov and others (2002a), Djankov (2002b), Johnson and others (1998), Schneider (2000), Schneider and Klinglmair (2004), Shleifer and Vishny (1993), Svensson (2005) and World Bank (2003).

Experts of the Center for the Study of Democracy (CSD), which is a local think tank, developed 86 the concept for registry reform in the period 2001-2003 by analyzing the situation and studying “best practices” (the Norwegian registration system was studied in-depth). The CSD also took part in discussions with the government and business associations of this concept, which was incorporated in the strategy, approved by the Council of Ministers in 2005. The concept targeted: a) unified, standardized and centralized registry operation; b) cheap and fast registration; c) simplified and secured procedures; d) electronic databases, publicly accessible through internet; e) unique identifier for each entity. See, CSD (2007). Trade Registry Act: Commentary, Sofia.

REFEREnces & ENDnotes

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87 The Action Plan for fight against corruption of the anti-corruption initiative 2000 has formulated the proposal to introduce a simplified administrative registration of commercial activities and simplified regime for real estate business transactions.

88 The Minister of Economy and Energy, His Excellency Petar Dimitrov, referred to these estimates in his presentation in the public discussion of the Better Regulation Program, Council of Ministers, March 17, 2008.

89 The Dealing with Licenses indicator regards procedures, time and cost for the construction of a warehouse (1300 square meters), including obtaining necessary licenses and permits, completing required notifications and inspections, and obtaining utility connections.

90 It is important, however, to keep in mind that the more indirect phrasing of the question in the 2005 could make comparisons difficult and that firms might be more likely to lie in the 2007 Enterprise Survey. See Iarossi (2006) or Recanatini and others (2000)for a general discussion on sensitive question.

Azfar and Murrell (forthcoming) discuss corruption questions in particular.

91 Due to the small number of firms in most sector that get licenses it is difficult to make comparisons across sectors with the data outside of food and garments, where there are a large number of firms.

92 Reichel, Motta and Evgeniev (2007) criticize the outdated classification system of rules for the hotel accommodations, lodgings and bars which required hotels with international reputation to level down their quality systems in order to respond to the rules in Bulgaria.

93 When a dummy indicating that the firm owns its land is added to the regression for access to land from Chapter 5, the coefficient is statistically significant.

94

Data from NSI (2006).

95

Preliminary data from NSI.

96

Preliminary data from NSI.

97 A recent report on Industrial Space across the World (2008) found that rents in the Central and Eastern European region has grown by 7 percent, whereas rents in Western Europe has grown by 1.3 percent. In fact, the report found that Sofia has become one of the ten locations where rent for industrial space is growing fastest (9 percent increase in 2007). See http://www.doingbusiness.ro/company_news. php?newsid=135. Another report, however, suggests that rents for industrial space in Bulgaria have remained stable in 2006 and 2007 ranging from 3.8 EUR/m² to 5.5 EUR/m², depending on the location, infrastructure and modes of transportation (Reichel and others, 2007).

98 bg/

According to Invest Bulgaria Agency (April 2007). See http://www.investbg.government.

35 Million BGN are considered for threshold of investment, if the initial investment is 99 implemented entirely within the administrative boundaries of municipalities where the rate of unemployment for the year last preceding the current year is by at least 35 percent higher than the national average.

100

Law of Spatial Planning (prom. SG.1/2, Jan.2001).

101

According to field interviews with relevant experts.

102

According to field interviews

103

US$7 million was financed by the Bulgarian Government

104 See governance indicators, developed by Kaufmann and others (2007). The Global Governance project, which combines results from numerous surveys and studies into a six governance indicators for 212 countries and territories between 1996 and 2006.

105 The court case concerns a legal dispute between 2 businesses in the largest city in the country (Sofia in Bulgaria) over a non-payment dispute between two firms for an amount equal to 200 percent of the country’s per capita income. There are no appeals in the assumed case. Other details of the case are described in World Bank (2007b).

106 The source of the data is a Survey on Emigration (nationally representative) organized by the Gallup Int., in the summer of 2006. http://www.mlsp.government.bg/bg/docs/BBSS_ Main%20Report_Emigration%20attitudes._Sept%202006_bg.ppt.

107

OECD (2007b)

108 About 20 percent of firms were concerned about labor regulation in the 2002 and 2005 BEEPS survey. Because the question is asked differently in the 2007 Enterprise Survey and the 2002 and 2005 BEEPS surveys (see Chapter 5), it is difficult to compare results from the two surveys. However, in general, because there were fewer categories in the 2002 and 2005 surveys and respondents tend to avoid the most extreme categories; these results suggest that concern might have fallen since the earlier surveys.

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109 There have been few changes in contractual regimes and labor contracts remain predominant.

In 2007, these contracts accounted for 92 percent of employment, while temporary jobs accounted for only 6 percent and part time jobs less than 2 percent. Flexible arrangements depend mostly on subsidies for programs and measures that support them and thus provide less flexibility than might be optimal (NSI).

110

Data are from the National Statistical Office.

111

Appendix 8.2 shows the econometric analysis that underlies this discussion.

112 It is important to note that credit also grew rapidly in other countries between 2005 and 2007, so this does not necessarily imply that Bulgaria’s relative position improved.

113 The Doing Business reports public registry coverage as the number of individuals and firms covered by a public credit registry as a percentage of the adult population, whereas it reports private bureau coverage as the number of individuals and firms covered by a private credit as a percentage of the adult population. The depth of credit information index measures the extent to which the rules of a credit information system facilitate lending based on the scope of information distributed, the ease of access to information and the quality of information, whereas the legal rights index measures the degree to which collateral and bankruptcy laws facilitate lending.