The public sector needs reforms. It’s a statement that everyone largely agrees with and that has been called into question in recent weeks. The government has announced measures to improve governance and public spending, as well as a tax package to boost revenue. While the tax legislation has, as expected, caused quite a stir, the administration’s possible reform has been seen as a communications move designed to sweeten the bitter pill of tax increases. Both packages of measures were based on an excessive budget deficit, which would lead to a potential loss of European funds.

However, European funds are the lifeblood that has recently been driving the economy and on which the continuation of economic growth next year depends. The IMF forecasts Romania’s economic growth at 2.2% this year and 3.8% in 2024, while countries in the region have weak growth or are at risk of entering recession. For its part, the rating agency S&P believes that the Romanian economy will register a growth of 2.3% in 2023, corresponding to almost 4% on average until 2026, given that our country will benefit from important European funds. In addition, S&P expects Romania’s commitments under the EU’s Recovery and Stability Mechanism to remain a pillar for political and fiscal reforms.

The impetus comes from big infrastructure and construction, both fueled by the investment of European money, which has contributed to growth at the same percentage as the traditional engine of recent years, consumption. It has slowed down mainly due to inflation, which from a macroeconomic point of view can be considered a positive phenomenon as it reduces the pressure on the current account and the budget deficit at a time when financing has become very expensive.

It is clear, especially at the turn of the year with four electoral votes, that the government wants to ensure that European money continues to flow into Romania, as domestic funds available for investment are scarce. Hence the urgency of reducing the budget deficit and meeting the requirements of the PNRR.

However, in the public space, all discussions revolved around budget deficits and tax increases, which, in fact, are only the consequences of the lack of deep changes in key areas of governance and public services. And these reforms, which contribute to the competitiveness of the economic environment and increase the quality of life, should concern us, the business environment and society as a whole. So, we come to the essence of the discussion: the reforms that the state should implement in management, wages, pensions, health care or education.

All areas dominated by the public sector lagged behind, and not because there were no reforms. On the contrary, there were dozens of initiatives that mostly failed without real political will: either because they were done with too short mandates, or because they were not consulted with all stakeholders to gain momentum, or they did not were carefully developed.

After all, reforms advance to the extent that there is a desire and ability to use resources and political mechanisms. The extent of their success reflects policy priorities that require long-term consistency and coherence, and this does not come without some heavy administrative “sacrifices” that must be accepted and put into practice.

The National Recovery and Resilience Plan, along with the funding and reforms that underpin it, filled out this short list of priorities to deliver major changes as well as address old challenges.

Overall, structural reforms related to the PNRR are considered important for a sustainable reduction of the fiscal deficit in the medium term, as they should reduce waste and inefficient spending while improving the quality of public services.

In addition, the administrative reform will free the state budget from significant costs. For example, many administrative-territorial units are not able to pay even salaries from their own incomes – a quarter of village municipalities found themselves in such a situation in 2022. There are about 3,000 administrative-territorial units and about 1,000 have less than 1,500 inhabitants. This is where the idea arose to combine some functions and services, which would reduce the administrative apparatus and costs, which relate not only to salaries, but also to other funds for functioning.

More than 1.2 million workers work in the public sector, and Romania ranks first in the European Union in terms of the share of total wage costs, with around 30%, while the average for member states is 23%. Spending on public sector personnel increased by more than 60% between 2017 and 2022 to more than €22.8 billion. Another very large expense that tends to grow, including due to the aging of the population, is social assistance. Pensions and salaries make up more than 70% of total budget revenues and about 90% of revenues from fees and taxes. In other words, the budget deficit is generated by these costs, and public investment becomes almost impossible to get from budget resources, which once again confirms the fact that Romania needs European money from the multi-year budget or from the PNRR as air.

At the same time, the question of the efficiency of spending public funds arises. For example, in 2015-2022, spending on health care increased by 143%, from 28 billion to 68 billion lei. However, no significant investments were made, and Romania took it upon itself through the PNRR to budget multi-year allocations for health infrastructure. In 2021, spending on education was 3.7% of GDP, the lowest level of any country in the European Union, where the average figure was 4.8%, which at least partially explains the very low performance of students in the PISA tests.

Although Romania has made impressive progress in improving economic performance and prosperity over the past two decades, reaching a GDP per capita of $15,000 according to the World Bank, the public sector is outdated and hinders economic competitiveness by wasting resources. An example is the slowness with which the reform and digitalization of tax administration is carried out, which would help to better collect existing taxes, reducing the danger of their sudden increase when the budget deficit can no longer be controlled.

Thanks to the PNRR, reforms were implemented in many areas of the public sector. The systems of education, health care, taxation, justice, wages and pensions are undergoing important but delayed changes.

Romania has so far raised around €9 billion from the PNRR, which represents pre-financing and the first two tranches. Unfortunately, no payment requests were submitted in 2023 due to late or missed milestones.

However, the planned reforms must be completed, since they have direct and indirect consequences in almost all areas and the recovery and development of the economy depends on them. Although businesses benefit little from PNRR, they indirectly have very large long-term benefits, as an integrated and indispensable public service delivery and distribution system has a direct impact on the entire society and economy.

This article is part of PwC Romania’s Agenda for Tomorrow editorial project, which will run until the end of this year and aims to discuss the context and perspectives that can guide companies to make informed decisions in the midst of change. You can read the first article here.

The article is signed by Dean Bumbetcea, Country Managing Partner, Daniel Angel, Partner, Head of Fiscal and Legal Services, and Mihai Anita, Partner, Head of Audit Services

Article supported by PwC Romania