Equity/Efficiency Trade-off in Romania

in contrast with Western Europe

1EC202 Public Economics and Finance

Bachelor in Economics

November, 2015

Table of contents

Introduction / Motivation...................................................................................................2
1.

The case of Trade-Off in Education in Romania vs Europe.......................................2

2.

The case of Trade-Off in Employment Policy in Romania vs Europe.......................2

3.

The Case of Trade-Off in Social Policies...................................................................2

Concluding remarks...........................................................................................................2
References.........................................................................................................................3
Appendix XXX...............................................................................................................4

Introduction / Motivation
The aim of this paper is to question the supposed efficiency and equity trade-off
in Romania and its implication in the education system, employment policy and in
peoples daily life in general in comparison with other countries from Western Europe.
In a perfectly competitive market, there would be no impact of inequality on
productivity, but there is not the case for Romania. Beside incomplete markets which
can explain this trade off, another justification can be the the political process, which
can ilustrate the relationship among inequality, government policy, and economic
growth. Political outcomes determining government policy are endogenous to the
distribution of income and rational economic agents vote for or against tax policies
which have redistributive consequences. Greater inequality would result in higher tax
rates since a larger proportion of voters will favor redistributive policies. As a result, the
after-tax return of capital is reduced, thus diminishing investment and economic growth.
The question that arises is what other countries do in terms of unemployment
policies or education and whether their measures are different and more useful from
those in my country.

1. The case of Trade-Off in Education in Romania versus Europe

Education is widely considered to be a means for offering individuals an
equal opportunity to improve their productivity and increase their future
earnings. The positive external effects of education are believed to justify the
public provision. However, despite these facts, in Romania, not all the children
have access to education and there are still differences between those who live in
rural area and urban areas.
Unfortunately, according to the social scientists, education structure is a
mirror of society structure. Income inequalities reflect themselves in education
inequalities. Poor people, who live in rural areas or in poor urban districts, are
used to sending their children to schools that are less well equipped for a good
education. Most of them face hard economic limitations to be able to send their
children to school at all. As a consequence, a real poverty trap emerges, for

many generations. Only 1-2% of the current students in universities come from
families living from agricultural activities in rural areas and only 5% from rural
areas, in general.
In order to offer a proper education to students and children, we should
firstly have the financial support to do so. Yet, during 2009-2012 the Romanian
Government allocated for the education system only 4% of the GDP, while
during the year of 2013 the amount of money decreased to only 2.5%. For the
year 2015 they estimated a percent of 3,7% of GDP for education. On average,
countries of the European Union allocate 6.4 % of their total public expenditure
to direct public-sector support for pupils and students in all education levels. In
addition, family allowances and tax relief are widely used methods of supporting
families with school-age children. In countries such as France, the budget for
education represents 5,5 % of the GDP, while in Germany represents 4%. The
highest investor in education is a northern country, Sweden, which offers 7% of
its GDP to education. The total annual unit cost per student in public institutions
was, on average, PPS (purchasing power standard) EUR 6 288 in 2008 prices,
according to a study conducted by Eurostat. In Romania the PPS had a value of
only 2220 Euros, three times lower than the average of the EU. According to the
National Institute for Statistics, Romania is the one of the countries which
allocates the least amount of money for this sector. According to the law, 6% of
the GDP should be distributed for education.
However, this is not the only problem that the education system
encounters. Education was a field for several reforms conducted by every
government, each of them lead to very bad results. Since 1989, the minister of
education has been changed 19 times. Instead of defending some areas of social
life such as education against market forces, successive governments have
not even started this struggle; on the contrary, they relieved privatization a
solution for an improved functioning of the education system; this attitude
resulted in the exclusion of those who have no money to pay and in an
unexpected decrease in the quality of education.
Paradoxically, Romania is the country where some of the most brilliant
young brains in the world are born. According to the Economist, here the rate
of gifted children is twice the average worldwide. In July, the country was

ranked first in Europe at the International Math Olympics and 10 th among 100
countries worldwide. Some of the most feared hackers in the world are operating
in Romania. Corporations like Microsoft have a big community of Romanians
among their workforce and they keep recruiting more. Most of these
achievements seem to be the result of the hard work of individuals combined
sometimes with the influence of a great teacher rather than the result of a
proficient education system. Not one of Romania's universities are ranked
among the top 500. However, the biggest university in the world is a Romanian
university (300.000 students in 2009); it provides the market with people having
many diplomas but less required skills. This is the main reason why many
college graduated children choose to study in countries such as U.K., Sweden,
Denmark. There, the universities offer to pay the tuition fee as long as the
students find a job in the country which can help them afford to pay back the
loan.
Tertiary education graduates integrate into the job market two times more
quickly than people with at most lower secondary education. At European Union
level, the average duration of the transition to the first significant job was only 5
months for people with tertiary qualifications, close to 7.4 months for the upper
secondary level and up to 9.8 months for people with lower education levels.
Despite of this, in Romania the situation is different due to the lack of jobs on
the market. Educated people are supposed to easily find a job, yet the capacity of
finding a job is lower for these people than for those who are less skiled. The
explanation of a generally lower unemployment rate for this category of people
comes from their availability to accept less qualified job offers when labour
market supply is inappropriate for their professional level and skills. It has often
been the case for Romania during the transition that researchers, engineers, or
other highly qualified persons have agreed to work in areas where their
competences are irrelevant, instead of not having a job at all. For the labour
markets current rules, such a situation seems to be progress as long as higher
employability and mobility are featured. Another perspective might reveal it to
be a misuse of human capital and an ineffective spending of public money, given
their former education.

Attempts to raise employability through active measures, such as

organizing training and lifelong learning face strange and regrettable situations
because of poverty effects. For example, a training programme failed, even
though it was well targeted and
well-funded, and was required by the labour market, because not enough persons
with
primary school level have been found among the jobless in need; poverty had
made these
young people drop-out from the educational system before graduating from
compulsory
primary school; in other words, illiteracy prevented them from attending the
training
course and from increasing their chances of employment.
In the Western Europe, families are encouraged to send their children to
school. Most countries combine family income with the number of children
living in the household as the basis of fee reduction or exemption. In the United
Kingdom, there are tax-credits for families below a certain level of income
where their child attends additional hours on a fee-paying basis. Parents on low
level or middle level incomes receive tax credits through the Working Tax Credit
Child Care Element paying up to 70 % of capped costs if they work at least 16
hours per week. In France almost all private schools are granted-aided and the
fees are very low. Private contributions for meals are adjusted according to
family income.
We can conclude that there is still a continually increasing lack of trust in
the education system in Romania comapred with other countries. Parents of the
children from rural areas consider that education, in general, can not ensure
personal progress and those who are wealthy do not trust the educational system
anymore due to the many changes that occured over time. Moreover, a large
majority of students in universities wants to leave the country immediately after
graduation while the managers do not wish to organize workplace qualification
courses anymore because, after acquiring the needed skills, many workers look
for a job abroad and leave the country. Without the help of the Government, we
can not have a proper educational system. As we can see before there are many
gifted students who can not benefit from education due to lack of money, which
in most of the cases is because of the inappropriate approach of the Government.

2. The case of Trade-Off in Employment Policy in Romania versus

Europe
Employment policies in Romania are in line with the new European
Employment Strategy. Romanian policy makers have made some important decisions
during the last 20 years which were meant to reduce the unemployment and help the
population. At the beginning of the 2000, the National Agency Foundation (ANOFM)
was set up in order to help people find easily a job. Moreover, the agency has become a
service provider for people looking for a job, now offering a wide range of services such
as professional counseling, vocational training, pre-dismissal services, labor mediation,
consultancy for starting a business, subsidized employment for people in disadvantaged
groups of population, providing favorable loans to create jobs, and more.
The recent economic crises forced the Romanian Government to take a series of
measures in order to maintain a stable level of economy. In 2009, it adopted 28 anticrisis measures among which maintaining the unemployment rate within acceptable
limits, keeping the flat tax at 16% and VAT at 19% and the allocation of approximately
20% of the investment budget. Hoping to reduce the unemployment rate and to alleviate
the effects of the economic crisis, the Romanian Government adopted an Emergency
Ordinance which provides that employers who hire the unemployed in 2010 will be
exempted for six months from social security contributions related to them. Employers
benefited from this feature only if the unemployed people were registered with
employment agencies for at least 3 months prior to the hiring decision and had no
relationships with those employers in the last 6 months prior to employment. This
measure was part of the package of anti-crisis measures adopted at the beginning of
2010 together with the provision of facilities for young people under 35 years who set
up companies, replacing the minimum tax with a flat rate, reducing the number of tax
return declarations to be completed by persons legal, compensation of reimbursed VAT

with recovered VAT, the initiation of public-private partnership law, and the
postponement in 2010 of income tax payment. The measures continued also with
reducing the wages of public employees by 25%, the pension fund by 15% and with
increasing VAT by 4 percentage points. All this was accompanied by massive layoffs in
the public sector so that from 2009 until present days 200,000 public servants remained
jobless.
According to recent measures made by the scientists, the unemployment rate has
a value of 6,8% in Romania, while the youth unemployment is recorded to be 22,3%.
The high value of the youth unemployment shows that despite the fact that student have
a diploma they can not find easily a job. Compared with the value if the EU, 20,1%, we
can state that the unemployment for people aging 15-24 years old is quite a serious
problem. One of the most valuable solutions, although not that obvious for some, for
reversing youth unemployment is to support entrepreneurship. Entrepreneurship comes
with two sources for decreasing unemployment: the more companies are set up, themore
will the number of employees increase; and the more young people become
entrepreneurs and become self-sustained. But in order to increase the number of
entrepreneurs, funding and mentoring is needed, two lines of action that are imperative
to supporting their activity (according to the EY study). The governement should also
finance large projects supporting apprenticeships and traineeships. Romania set up 27
pilot Youth Guarantee (YG) centers aimed at identifying young NEETs (Not in
Education, Employment, or Training) and providing packages of personalised services,
but their impact and coverage remain uneven. Public employment services (PES) are
developing an integrated database of non-registered NEETs and putting in place new
measures supporting early activation for them, but their capacity to effectively reach
out, support and activate young people remains a challenge
Despite the youth unemployment, Romania is now facing huge difficulties
concerning its further development because of the drain of human resources. Creating
enough jobs for those willing to work is still an unachieved goal for every government,
bigger factor than making the jobless occupy the unoccupied jobs. As a consequence,
people choose to leave their homes to find a job abroad. Those who are still in the
country and are looking for a job, can benefit from the unemployment benefits for a
period between 9 and 15 months and the general amount is 75% of the minimum wage

together with a bonus from 3% to 10% of previous income, according to the years of
contribution; the lack of new opportunities puts the jobless in a even more precarious
position. OECD promoted strongly the composite index of the strictness of employment
protection legislation (EPL) as an instrument to enforce the idea that flexibility would
reduce unemployment.
Another aspect that we may seem dubious about is the practice of referring to
social contributions as being a simple burden and not a part of security protection, and
therefore, a part of everyones salary. Cutting contributions is currently seen as a mean
of reducing labour costs and also unemployment. As there are no concrete obligations
for employers to create jobs when cutting social contributions, whenever such policies
have been implemented, the results were deceiving - neither the price level has
decreased, nor the number of jobs has increased, at least not enough to justify the effort.
This is another piece of evidence for the weak link existing between labour cost and
employment. In Romania, the number of those earning the minimum wage has almost
doubled during the past ten years; the number of employees remained constant.
A country in which unemployment rate has a low value is Germany, with 5,3%
of the population who has not a job. This may be a consuquence of their policy.
Germanys far reaching employment regulation is based on different sources resulting in
a high degree of legal complexity and juridification by specialized employment
legislation (and social policy rules), by court-based law-making (Labor Courts and
Social Courts), and collective agreements at sector or regional level as well as firmbased agreements with works councils. An example of a policy introduced in Germany
which encourages employees hire people and enlarges the employment flexibility is low
level part-time work not covered by full social insurance contributions. Although it is
not differentiated in terms of employment protection in a narrow sense, it allows
employers to reduce labor costs. The most recent reform implemented in 2003 increased
the maximum earnings of those marginal jobs or minijobs to 400 per month.
While the employer has to pay full social security contributions and a lump-sum tax,
amounting to 25% (as of mid-2006 30%) of the gross wages, earnings from mini-jobs
are tax- and contribution-free on the employees side.
As a conclusion, we can sum up that a higher intervention from the public sector
would reduce the differences between the jobless people and employed ones. A change

in the market concerning the wages is also a suitable solution for the current situation on
the market and an increase in a salary depending on the productivity of each individual
would be proper.

1 The Case of Trade-Off in Social Policies

Equity can go hand in hand with more efficiency. In other words, a
generous level of social protection does not necessarily lead to inferior economic
results. On the contrary, social policies based on investment in human and social
capital are conducive to higher economic efficiency for they improve the
productivity and the quality of the labour force. Social policy is therefore a
productive factor, even though its costs are generally visible in the short term,
while its benefits are often only apparent in the long term. The lack of coherent
social policies and a low level of social spending put economic development at
risk and create third-world models of development, based on a cheap labour
force, exports of raw materials, a high dependence on foreign capital movement
and external markets. A cheap labour force does not mean having lower costs,
only being paid worse. The Romanian governments have made such a choice.
Far from being an expression of the generosity of wealthy people or
governments, social benefits are the result of a moral and ethical choice made in
many of our Europe an societies and a few other non-European countries.
The adequacy of social assistance is measured by the net income of
people on social assistance relative to the median equalized income. Here,
member states differ substantially in terms of the minimum safety nets they
provide to jobless households, even when they are compared to the at-risk-ofpoverty threshold which depends on the living standards within each country.
Only a few countries provide households with a minimum income and related
benefits (for example housing) that are sufficient to lift them close to, or above,
the 60% median income threshold. The chart below shows that the most
generous system is that of Ireland, which allows people living on social

assistance to have more than 70% of the median equalized income. The worst
case is Greece, where people living on social assistance receive only 3% of the
median equalized income.

The inequality in a society is usually measured by the GINI index: in the

case of maximum inequality, it equals one, and it corresponds to zero when all
incomes are equal. While UK, Spain and Greece have similar level of social
spending, the ability of their welfare system to reduce the GINI coefficient range
from 7 percentage point in Spain to almost 20 percentage points in UK. An
interesting case is that of Ireland, which spends less than other countries like
Germany, Denmark, France, but its expenditures are able to obtain a higher
degree of equalization. In Romania, the progressive taxation system in force was
replaced in 2005 by a flat tax rate of 16%; the first concrete social result was a
deepening of inequalities. Inequality of income distribution (GINI coefficient)
has increased only in a few years of application from 36.3 (in 2004) to 37.8 (in
2007), while in most of the European Member States, this coefficient varies
between 23 and 30.
Based on the EU criterion, the proportion of the EU population at risk of
poverty in 2012 was 24%. This figure marks a significant deterioration of the
social landscape in Europe, caused especially by the economic crisis, which
continues to bite. The highest numbers of people in poverty (compared to the
national population) were recorded in Bulgaria (49%), followed by Romania

(41%). The lowest were recorded in 2012 in the Netherlands and Czech
Republic (15%) followed by Sweden (17%), and Luxembourg (18%).
In Romania, 4,1% of the population is living with less than 3 dollars a
day. A measure that can reduce the poverty is to guarantee a minimum income.
The minimum wage is almost 240 euros per month, while in countries such as
France has a value of 1500 euros, Spain 760 euros. The level of the minimum
income is a strong incentive for leaving the country. The minimum wage
remains among the lowest in the EU, although its level has been increased
significantly. If the government reduced the income inequality and poverty this
may expand and stabilize consumers demand, increase poor peoples investment
in education, and heighten workers motivation and workplace cooperation,
speeding up recovery.
The government hardly makes any improvements in the social assistance
system. Moreover, the adoption of the Strategy for Social Inclusion and
Combating Poverty and its Action Plans was delayed to March 2015. Limited
progress was made in adopting the Minimum Insertion Income, which would
simplify social assistance. To strengthen the link with activation measures, a
social economy law was adopted by the Government in 2013, but is still under
debate in the Parliament. According to the most recent report Country Report
Romania 2015 made by the European Commission the effectiveness of social
transfers is hampered by the absence of a mechanism to automatically adjust
benefits levels by updating the Social Reference Index. According to the social
assistance reform, all benefits are linked to the Social Reference Index. So far,
benefits have been adjusted on an ad hoc basis by arbitrarily changing their
relative value with respect to the Social Reference Index, while the value of the
latter has been kept frozen (at 500 RON) since 2008, in spite of a cumulative
inflation rate of 28 % between 2008 and 2014. As a consequence, in the absence
of a coherent methodology for updating the Social Reference Index, the value of
benefits such as the child rearing allowance, the heating benefit and the
unemployment benefit diminished in real terms, triggering a significant increase
in the severe material deprivation rate for the unemployed in 2013. The only
update in the last 6 years was represented by increasing the disability benefits by
16 % starting with January 2015.

There appears to be an inverse relationship between the generosity of

welfare benefits and the rigidity of labor-market regulations. That is, those
countries with high benefits tend to have more flexible labor markets, and vice
versa. That factor reflects a deliberate choice and a division between northern
and southern Europeover how to best balance policies that promote economic
growth with social responsibility. Nordic countries, in addition to Germany, the
Netherlands, and a few others, have chosen to pursue what is often referred to as
the Nordic, Danish, or flexicurity model. That version of the welfare state
combines a largely deregulated labor market, one that makes it easier to hire and
fire workers, with a generous safety net to cushion workers from the
consequences of those policies. As the Danish government says: The aim of
flexicurity is to promote employment security over job security. The model has
the dual advantages of ensuring employers a flexible labour force while
employees enjoy the safety net of an unemployment benefit system and an
active employment policy. Therefore, in southern Europe, the welfare benefits
may not deter work to the same extent, but finding a job may be more difficult.
Then again, in countries with flexicurity, it might be easier to find a job, but
benefits and effective marginal tax rates are high enough to discourage workers
from doing so.

Source: http://object.cato.org/sites/cato.org/files/pubs/pdf/pa779_1.pdf
In 2012, Belgium introduced streamlined, personalized job search
assistance for ablebodied beneficiaries. Two of the central member states of the
EU, France and Germany, have for the most part failed to match the
improvements in some of the other member states. France removed age
restrictions for social assistance eligibility and announced plans to build 15,000
new buildings a year over a period of three years to support access to housing
by young people especially those under 30. On the other hand, France has
announced plans to merge the earned income supplement (revenu de solidarit
active) and the employment bonus (prime pour lemploi) into one benefit, the
prime dactivit, starting in January 2016. The change is intended to simplify the

system and better reward work while also making younger people who work a
significant amount eligible for the new program. The new benefit would be paid
monthly and would be linked to earnings and household resources. Although this
change could end up being a step in the right direction, it remains to be seen how
this reform will be implemented in practice, and it still makes up only one small
component of the overall welfare system in France. Finally, Germany increased
the minimum income benefit, imposed a new national minimum wage, and
introduced new benefits such as a school lunch benefit for children from lowincome households and a child-rearing benefit.
As noted, benefits tend to be higher in countries with more flexible labor
markets. This trade-off between benefits and labor market flexibility makes it
difficult to draw any effective correlation between benefit levels and
unemployment rates.

Concluding remarks
Reducing income inequality may expand and stabilize consumer demand,
increase poor peoples investment in education, and heighten worker motivation and
cooperation. In Romania, higher social expenditure would have prevented the human
resource drain. For many of the romanians, a good education for their children or better
health care provision constituted the decisive reason for leaving the country. Constant
attention paid to social protection during the transition would have avoided the country
going into economic recession as deeply, by strengthening domestic demand and
limiting the very high dependence on external markets.
In addition, social services could become a significant source of new jobs,
helping the country to absorb female unemployment, especially. The government cannot
save money by maintaining inequality and exclusion; less redistribution does not
necessarily result in lower expenditure on social services, as what is not spent on
reducing inequalities ends up being spent on dealing with their results (for example
crime, drug treatments, health care). Investing more in cohesion policies could be a
balanced solution for dealing with both goals higher efficiency and a more equitable
society.

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