Commission Report 2002 (Romania)

The capacity to cope with competitive pressure and market forces within the Union

The ability to fulfil this criterion depends on the existence of a market economy and a stable macroeconomic framework, allowing economic agents to make decisions in a climate of predictability. It also requires a sufficient amount of human and physical capital, including infrastructure. State enterprises need to be restructured and all enterprises need to invest to improve their efficiency. Furthermore, the more access enterprises have to outside finance and the more successful they are at restructuring and innovating, the greater will be their capacity to adapt. Overall, an economy will be better able to take on the obligations of membership the higher the degree of economic integration it achieves with the Union before accession. Both the volume and the range of products traded with EU Member States provide evidence of such integration.

The lack of macroeconomic stability and structural reforms has held back the reallocation of resources towards more productive uses. Several factors have hindered the restructuring of the economy, such as limited financial discipline, tax arrears and other forms of quasi-fiscal subsidies, sporadic price controls, ad-hoc trade restrictions, an underdeveloped financial sector and, until recently, a reluctance to adjust the relative level of administered prices. By depressing investor confidence and affecting the business environment, a volatile macroeconomic environment, an unstable legal framework, and a limited enforcement capability by inexperienced regulatory agencies also helped to slow down the process of restructuring.

To maintain and upgrade the country's human capital, Romania's education system should be strengthened and active labour market policies further developed. At 3.3% of GDP on average, general government spending on education has been stable but low. Schooling is compulsory for only eight years. The participation rate of students aged 16 to 24 is relatively low, albeit rising. Some 70% of students in upper secondary and post-secondary education are enrolled in vocational courses. A small but increasing percentage of total students is enrolled in post-secondary and tertiary education. As a result, despite some recent improvements, the average education level remains relatively low with less than 10% of the total labour force having completed tertiary education in 2000. Spending on R&D has dropped to less than 0.5% of GDP in 1999. Although passive measures still represent the bulk of labour-market policies, the authorities have designed and implemented an increasing array of active measures. These, however, are still heavily concentrated on subsidies to employment rather than training measures. Moreover, while labour-market policies can play a useful complementary role, they cannot supplement the restructuring measures needed to solve the extensive underemployment of labour resources in Romania.

Only sustained growth within a more stable macroeconomic environment will make available the resources needed to upgrade Romania's capital stock. The transport infrastructure is inadequate and suffers from a lack of investment with motorway construction resuming only recently for the first time since 1997. Energy sector infrastructure has also deteriorated. Forced to provide quasi-fiscal subsidies to the rest of the economy, energy companies have been left without the resources needed for investment. An obsolete capital stock and irrigation network have made the agricultural sector particularly vulnerable to the vagaries of the weather.

The level and quality of investment spending must increase to support the long-term development of the economy. Gross fixed capital formation averaged 19% over the period. After declining during the recession from 21.2% in 1997 to 17.7% in 1999, the investment ratio started rising again in 2000, reaching 19% of GDP in 2001. There are some doubts about the soundness of the business decisions underlying much of this investment activity as state-owned companies were responsible for more than 60% of all gross fixed capital formation carried out by enterprises. Despite the poor state of public infrastructure, gross fixed capital formation by the general government only amounted to 1.8% of GDP on average. FDI inflows are playing an increasing role even though the cumulative stock of FDI remained low on a per capita basis at EUR 245 per head in 2001. Yet, since 1997, net FDI inflows have remained rather stable on an annual basis, equalling 3.5% of GDP on average. As a result, the 1997 FDI stock had doubled by 1999.

Despite important progress in some sectors, restructuring is still incomplete. The breadth and depth of enterprise restructuring has been uneven. The positive performance of some industrial sectors, like textiles, footwear, furniture, and electrical equipment, indicates that restructuring is beginning to bear fruit in those sectors where it has been carried out more aggressively, largely thanks to faster privatisation. Significant progress has also been achieved in some sensitive sectors, like banking, mining and shipbuilding. Despite a chronic gap between policy announcements and implementation, restructuring has also advanced in most other sectors, including agriculture, steel and energy, where the formerly integrated enterprises have been unbundled and slowly prepared for sale. However, privatisation and restructuring are not yet completed in most sectors and are at a relatively early stage in some. In particular, several large loss-making enterprises that actually subtract rather than add value have survived with little or no restructuring thanks to direct and indirect government support. This has weakened market incentives and deprived the budgetary and private sectors of scarce resources. It has also precluded a faster and deeper restructuring of the energy sector, which has become the main provider of quasi-fiscal support following the restructuring of the banking sector. Finally, as illustrated in the relevant chapter of this Report, serious economic and institutional weaknesses still hamper rural and agricultural development.

The structural composition of the economy reflects the incompleteness of the transition process. The share of the service sector in gross value added increased some 10 percentage points to 51.3% in 2001. The counterpart to this expansion in the tertiary sector has been an equally distributed decline in the share of gross value added produced by industry, down to 28.5% by 2001, and by agriculture. At 14.6 % of GDP in 2001, however, the latter`s share is still relatively high while the increasing number of agricultural workers points to a large deterioration in sectoral productivity. Moreover, the sectoral structure of gross value added has been relatively stable since 1998.

A growing acknowledgement of the role played by SMEs could lead to a better environment for their development. Operating mostly in retailing and manufacturing, SMEs play an increasingly important role, explaining a rising share of turnover and gross value added, respectively 56.1% and 39.5% in 2000. Between 1997 and 2000, SMEs accounted for more than half of total turnover, a quarter of all exports, and a fifth of all investment carried out by enterprises. The share of employees working in SMEs also increased sharply, rising from 33% in 1997 to 47% in 2000. In line with SMEs` growing economic relevance, the authorities have taken various steps to facilitate their development, instituting a Ministry for SMEs in 2001. Notwithstanding these initiatives, Romania still lacks a coherent and effective SME strategy. In any case, apart from specific targeted programmes, SMEs would greatly benefit from faster progress towards more general and fundamental policy goals such as the completion of the privatisation process, the sound development of the financial sector, and the establishment of stable legal, regulatory and tax frameworks.

Although decreasing over the period, government intervention has continued to affect enterprises' competitiveness, thereby holding back the process of restructuring. Advances in domestic and external liberalisation coupled with progress in privatisation have reduced the influence of government policy and legislation on competitiveness. However, successive governments have continued to shelter a slowly diminishing number of sectors and enterprises from market discipline. This was achieved through the provision of explicit budgetary subsidies as well as through other less transparent and more pervasive forms of support. At different points in time, these have included controlling the price of key inputs for certain production sectors, writing off tax arrears to the budget on a regular basis, tolerating mounting inter-enterprise arrears, granting borrowing guarantees and implementing discriminatory trade and fiscal measures. Although some progress has been recorded on most of these aspects, it is still insufficient.

Under the impulse of increased liberalisation, Romania's economy has become more open and increasingly integrated with the EU. At 75.1% of GDP in 2001, the value of exports and imports of goods and services was some 15% higher than in 1997. Already Romania`s main trading partner in 1997, the EU has further increased its predominant role. By 2001, it accounted for 67.8% of the total value of Romania`s merchandise exports against 56.6% in 1997.

Increased trade integration has been accompanied by a sustained shift in specialisation away from heavy industries towards low value-added activities in light manufacturing. The share of metals, minerals and chemical products in the total value of merchandise exports has decreased, dropping from 33% in 1997 to 25% in 2001 while that of clothing, footwear and electrical equipment has increased from 38% in 1997 to 50% in 2001. Such trends reflect the progressive but incomplete dismantling of the artificial trade specialisation inherited from the control economy. With a more flexible exchange rate regime, relative unit labour costs have been broadly stable since mid-1999. Against this background, the strengthening of the private sector, particularly SMEs, and the development of a wide subcontracting network with foreign firms aimed at taking advantage of Romania`s cheap labour have underpinned the growth of the most dynamic export industries. Without an increase in the proportion of local value added, however, Romania`s export sector remains characterised by a high import requirement and dependent upon relatively low wage costs and favoured access to the EU markets within the framework of outward processing trade.

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