## sipea2026048

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---

### A. Growth drivers and performance
- Average real GDP growth since 2001: about 2.6 percent annually.
- Comparison: other Western Balkan countries averaged 3.5 percent.
- Sub-period dynamics:
  - Pre‑Global Financial Crisis: growth exceeded 5 percent in several years.
  - 2009–2019: economic activity moderated to about 2.4 percent.
  - 2021–2025: growth averaged about 3 percent.
- Demand-side contributions:
  - Private consumption contributed between 3.0 and 3.4 percentage points to GDP growth in pre‑GFC and post‑COVID periods.
  - Private investment contributed 1.4–1.7 percentage points across all periods.
  - Public consumption: modest contribution.
  - External sector: mostly negative contribution.
- Production-side dynamics:
  - 2001–2008: balanced gains from labor, capital, and TFP.
  - 2009–2019: TFP’s contribution turned negative; capital accumulation became more prominent.
  - 2021–2025: productivity accounted for the majority of output gains; labor contribution weakened and turned negative amid demographic aging and emigration.
- GDP per capita (PPP):
  - Nearly doubled since 2001; in 2024 it stood at 43 percent of the EU average.
  - Output per capita growth: around 3.0 percent per year (North Macedonia) vs. 3.7 percent for other Western Balkan countries.
  - “Half-life” of the income gap at current pace: almost 20 years.
- Labor supply outlook:
  - UN projections indicate continued emigration will shrink the working-age population, leading to a 0.5 percentage point decline in employment by 2030.

### B. Estimating potential output
- Definition: potential output = level of real GDP consistent with low and stable inflation (NAIRU-consistent), reflecting full and efficient utilization of labor, capital, and technology.
- Univariate filtering results (dual Hodrick–Prescott on annual and quarterly GDP from 2001):
  - Potential output growth averaged around 2.6–2.8 percent over 2001–2025.
  - Slowing from 3.4–4.0 percent before the global financial crisis to 2.3–2.4 percent in the subsequent decade (excluding 2020).
  - Pickup in potential growth in 2025 to about 2.6–2.7 percent.
  - Implied positive output gap in the range of 0.7–1.0 percent in 2025.
- Multivariate filtering models (Kalman filter; semi-structural New Keynesian design):
  - Annual model: reduced-form with unemployment dynamics and Okun’s law.
  - Quarterly model: Quarterly Projection Model (QPM) with more detailed supply side and monetary policy block.
  - Multivariate models broadly consistent with HP filter; point to somewhat larger positive output gaps in the most recent period.
  - Combined assessment: potential output growth in 2025 estimated at about 2.9 percent.
- Table summary (percent averages):
  - 2001-2008: HP Filter (Q Model) 4.0; Multivariate Filter (Q Model) 4.1; HP Filter (A Model) 3.3; Multivariate Filter (A Model) 3.4; Average 3.7
  - 2009-2019: 2.3; 2.2; 2.3; 2.4; Average 2.3
  - 2021-2025: 2.3; 2.5; 2.2; 2.4; Average 2.3
  - 2001-2025 1/: 2.8; 2.8; 2.6; 2.6; Average 2.7
  - 2025: 2.7; 3.4; 2.8; 2.6; Average 2.9
  - 1/ includes 2020

### C. Estimating the medium-term GDP impact of structural reforms
- Framework and assumptions:
  - Frontier defined as average of the two best-performers among European economies and the United States, normalized to 100.
  - Benchmark assumption: North Macedonia closes 50 percent of its gap relative to the CESEE frontier.
  - Output Gains = Closed Policy Gaps * Output Elasticities (elasticities drawn from IMF and OECD studies; five-year horizon).
  - Caveats: aggregation assumes additivity across reform areas; may over- or under-estimate due to interactions, complementarities, and omitted indicators.
- Structural policy areas covered: governance; labor and human capital; business regulation; R&D and digitalization; credit and capital markets; external sector.
- Distance-to-frontier (2022): North Macedonia ranks below the 25th percentile and CESEE average in most areas except business regulation.
- Reform-specific estimated five-year gains (closing 50% of gap):
  - Labor market and human capital: total increase of 6.6 percent in GDP.
    - Closing labor force participation gap: 5.5 percent.
    - Closing human capital index gap: 1.1 percent.
  - Business environment (combined four areas: business regulation, R&D and digitalization, credit and capital markets, external sector): total increase of about 4.6 percent.
    - Lower external trade restrictions (MATR): 2.5 percent.
    - Improvements in product market regulations (PMR): 1.0 percent.
    - Deeper financial markets: 0.6 percent.
    - Higher business R&D spending: 0.5 percent.
  - Governance (proxied by control of corruption from WGI): 2.7 percent.
- Combined effect:
  - Cumulative medium-term output gains of about 14 percent from the selected reform package (roughly 2–3 percent additional annual growth, nearly doubling current estimates of potential growth).
  - Robustness checks re-weighting governance elasticities toward countries similar to North Macedonia yield results nearly identical to baseline.
  - External supporting evidence: World Bank (2025) simulations show medium-term gains of about 15 percent under narrower reforms.

### D. Role of the EU Reform and Growth Facility (RGF) and priority reform areas
- EU Growth Plan context:
  - World Bank estimates: full implementation of RGF reforms (closure of 70 percent of critical gaps with the EU in five key areas over 20 years) could boost baseline annual GDP per capita growth in Western Balkan countries by up to 3 percentage points.
  - Five priority areas under RGF: (i) digital infrastructure; (ii) regulatory quality; (iii) government effectiveness; (iv) financial development; (v) female labor force participation (LFP).
  - Largest estimated growth dividends under RGF: regulatory quality (1.13 pp), government effectiveness (0.95 pp), digitalization (0.63 pp); female LFP (0.35 pp); financial sector development (0.03 pp).
- RGF financing and progress for North Macedonia:
  - Eligible for up to €750 million in grants and favorably priced loans over 2024–2027, conditional on reform milestones.
  - As of latest assessment: completed 6 of the 50 steps (12 percent) and received €76 million, including €52.5 million in pre-financing.
  - Progress concentrated in: digital transition legislation; strengthening financial controls; SOE management (requirements for independent board members); labor and market inspections.
  - Pending milestones include: optimizing para-fiscal charges; establishing a comprehensive SOE register; advancing railways restructuring.
- Policy priority implications:
  - Labor market and human capital reforms, improvements in the business environment, and stronger governance (notably control of corruption) deliver the largest medium-term gains.
  - Governance reforms amplify payoffs from labor and business environment reforms; IMF (2019) finds gains from reforms can be more than twice as large in economies with strong governance compared with weak governance.
  - Sequencing and reform packages matter for maximizing and sustaining medium-term output gains.

### E. Growth payoffs and reform priorities (actionable)
- Closing 50 percent of reform gaps compared to the CESEE frontier could raise medium-term GDP by around 14 percent.
- Largest contributions to the 14 percent GDP gain are:
  - Labor markets and human capital: 6.6 percent
  - Business environment: 4.6 percent
  - Governance: 2.7 percent
- Priorities align with North Macedonia’s Reform Agenda supported by the EU RGF.

### F. Labor market challenges and policy measures
- Supply-side gaps and constraints:
  - Female labor force participation remains approximately 20 percentage points below the EU average.
  - Youth unemployment is about 29 percent for those aged 15–24.
  - Persistently elevated rates of NEET.
  - Emigration projected to reduce employment by around 0.5 percentage points by 2030 (Ayerst and Kovachevska Stefanova, 2025).
  - Low adult participation in learning and training; vocational programs insufficiently aligned with employer needs.
- Demand-side constraints:
  - Labor productivity has risen by a cumulative 15 percent since 2019.
  - Post-pandemic annual productivity growth accelerated to around 5 percent.
  - Real wages have outpaced productivity, pushing the real wage–productivity ratio up by around 18 percent and eroding external competitiveness.
  - Collective wage-setting mechanisms in the public sector weakly linked to productivity.
  - Labor code broadly aligned with EU benchmarks (Annex II), but high informality and concentration of employment in low-productivity sectors persist.
- Policy recommendations to narrow gaps:
  - Expand affordable childcare and widen use of flexible work arrangements.
  - Strengthen activation and re-skilling programs; improve ALMP design and governance.
  - Increase adult-learning participation, strengthen vocational education and training, and enhance recognition of non-formal and informal learning.
  - Gradually increase the statutory retirement age for women to mitigate workforce losses from emigration and aging (Ayerst & Kovachevska Stefanova, 2025; IMF Article IV, 2025).
  - Lower the labor tax wedge to boost participation and reduce barriers to formal employment (IMF, European Department, 2024).

### G. Governance reforms
- Key diagnostic and priorities:
  - Governance weaknesses—including corruption—materially impact macro-financial stability, investment, human capital accumulation, and total factor productivity.
  - North Macedonia has almost halved its WGI-based governance gaps relative to economies that joined the EU since 2004 over the past 24 years, but progress is uneven, especially for the rule of law and corruption control.
- Priority governance measures:
  - Strengthen judicial independence and integrity through transparent, merit-based appointments; enhance accountability; ensure adequate staffing and resources; fully operationalize case management systems; implement the 2024–2028 Judicial Reform Strategy.
  - Adopt a new Criminal Code aligned with EU and international standards; improve the track record in high-level corruption cases via stronger financial investigation and confiscation tools.
  - Reinforce the capacity, independence and credibility of the State Commission for the Prevention of Corruption; improve effectiveness of asset and conflict of interests’ declarations.
  - Accelerate implementation of the national anti-corruption strategy; prepare a credible, well-prioritized updated 2026–2030 strategy with clear institutional responsibilities, sequencing, and adequate resourcing.
  - Strengthen coordination, data exchange and integrity systems across institutions responsible for prevention, detection, investigation, and prosecution of corruption.

### H. Business environment, investment policy, and formalization
- Key priorities to foster investment and competitiveness:
  - Strengthen transparency and digitalization.
  - Ease regulatory and financial constraints on SMEs.
  - Simplify licensing and permit procedures; streamline administrative, licensing, and registration fees.
  - Foster entrepreneurship and innovation; enhance integration in the EU internal market and alignment with EU legislation.
  - Strengthen internal trade policy by improving connectivity, promoting fair competition, transparency, consumer protection and legal certainty.
  - Promote formalization through strengthened tax compliance, and reduce regulatory delays and inconsistencies (Article IV, 2024).
- Investment and state aid:
  - Shift from a model centered on generous tax incentives and export-oriented FDI toward a broader competitiveness agenda with performance-based and EU-consistent state aid to strengthen linkages with domestic firms and support productivity.
  - Further tariff alignment with the EU and progress in customs efficiency to facilitate trade.

### I. Digitalization—public and private sector
- Public sector digitalization priorities:
  - Strengthen integrated e-government services and platforms; improve interoperability and data sharing.
  - Expand use of digital tools for more efficient and transparent service delivery.
  - Digitalize public financial management systems through IFMIS to enhance transparency, strengthen budget execution and capital projects oversight, improve compliance, lower costs, and improve revenue mobilization.
  - Address weaknesses in e-government strategy and coordination, architecture and infrastructure maturity, digital identity, signature and trust services.
- Private sector digitalization and skills:
  - Connectivity indicators: 91.2 percent of households have internet access and 89.2 percent daily users.
  - Digital skills gap: 28.5 percent of the population possess basic or average digital skills compared to the EU's 60.4 percent (Eurostat, 2026).
  - Priorities: national digital skills framework, targeted reskilling programs, strengthening digital capacities in the private sector, support for SME and startup digital adoption, improved access to finance, public‑private partnerships, coordinated donor support, transparent management of funds for business digital transformation.
  - Establish a flexible and robust legal and institutional framework for the safe and ethical use of AI; invest in talent attraction, research centers, and laboratories to strengthen competitiveness and align with EU standards.

### J. Building a cohesive reform roadmap
- Reform complementarities and sequencing:
  - Reform bundles outperform isolated actions; complementarities raise returns (IMF, 2019; Budina et al., 2023).
  - Examples: improved judicial efficiency enhances contract enforcement, lowers corruption, increases returns to human capital investment, and improves the business environment.
  - Digitalization raises productivity and reduces administrative burden, strengthening the business climate and fiscal management.
- Timing and political economy:
  - Reforms implemented in good times generate larger and faster output gains; easier implementation during periods of strong growth and favorable external conditions (IMF, 2019).
  - Political mandate and fiscal space reduce opposition and increase the effectiveness of reform compensation measures.
- Strategic sequencing:
  - Prioritize governance reforms early because they both generate direct growth gains and amplify impacts of labor market, business environment, and digital reforms.
  - With stronger governance, labor market, human capital and business-environment reforms can become the main engine of medium-term growth.
- Expected impact if implemented decisively and aligned with RGF milestones:
  - Sustain annual growth up to 2–3 percent higher than current potential, more rapidly narrowing the income gap with the EU.

### K. Model specification and QPM features (methodology)
- Annual multivariate model (Kalman filter; Alichi et al., 2015 framework):
  - Treats potential output as latent, decomposed into trend and cyclical components.
  - Uses real GDP, CPI inflation, and the unemployment rate; estimation with the Kalman filter in a Bayesian framework.
  - Key processes: potential output level, growth rate of potential, and output gap with mutually uncorrelated white-noise shocks.
  - Inflation dynamics via Phillips Curve: links inflation to current output gap, lagged inflation, forward-looking expected inflation, and an inflation shock.
  - Labor market block: unemployment gap, Okun’s law linkage, NAIRU dynamics with time-varying NAIRU and persistent trend variations.
  - Outputs: potential output, potential growth, and output gap at annual frequency; end-of-sample identification aided by 5-step ahead growth and inflation forecasts.
- Quarterly QPM (reduced-form New Keynesian semi-structural model):
  - Operates at quarterly frequency for medium-term projections and monetary policy assessment.
  - Links aggregate demand, sectoral hybrid Phillips curves, monetary policy, and the external sector.
  - Aggregate demand specification: output gap depends on lagged output gap, real interest rate effects, potential output gap, and shocks.
  - Sectoral hybrid Phillips curves for core, food, and energy/other inflation with backward- and forward-looking components and dependence on sectoral real marginal costs.
  - Under fixed exchange rate peg: exchange rate is the nominal anchor, expected depreciation zero; domestic interest rates modeled using UIP with a risk premium containing trend and gap components tied to domestic and foreign output gaps, real exchange rate gaps, and net foreign assets/GDP.
  - Long-run real UIP condition ensures consistency between trend real interest rates, trend real exchange rate, and country risk premium trend.
  - QPM includes identities and parameter anchoring for internal consistency in projections.

### L. Structural reform elasticities and reported medium-term effects (selected quantitative highlights)
- Selected indicator elasticities and reported MT GDP effects (preserve formatting from source):
  - Labor force participation, total — World Bank; labor force as a share of the population aged 15 and above. 60.0% Labor Share of Income
  - Human capital index — United Nations Development Programme; higher values indicate stronger human capital. 9.4% Égert and Gal (2017) and Égert (2017)
  - Measure of aggregate trade restrictions — IMF; higher values indicate more restrictive trade regime. 0.9% Estefania-Flores et al. (2022)
  - Product market regulation (PMR) — OECD Product Market Regulation database, higher values indicate greater barriers. 2.5% Budina et al. (2023)
  - Business sector R&D as a % of GDP — OECD RDS; business-funded R&D expenditure as a share of GDP. 0.8% Égert and Gal (2017) and Égert (2017)
  - Financial markets depth — IMF; higher values indicate better performance. 3.5% International Monetary Fund (2019), Chapter 3
  - Governance — Control of corruption — World Bank, World Governance Indicators; higher values indicate less corruption. 3.6% Budina et al. (2023)
- Aggregate and area-level reported medium-term effects (preserve values as presented):
  - Labor market & human capital: 6.7%
  - Business environment: 4.6%
  - Labor force participation, total: 5.6%
  - Human capital index: 1.1%
  - Measure of aggregate trade restrictions: 2.5%
  - Product market regulation (PMR): 1.0%
  - Business R&D and digitalization: 0.5%
  - Financial markets depth: 0.6%
  - Governance — Control of corruption: 2.7%
  - Total effects: 14.0%

*Source: IMF staff. sipea2026048 - 2.   Real GDP Growth Decompositions: Demand and Production Side (May 12, 2026).*

### 2.   Real GDP Growth Decompositions: Demand and Production Side ___________________ 4

### 2.   Real GDP Growth Decompositions: Demand and Production Side

### A. Growth drivers and performance
- Average real GDP growth since 2001: about 2.6 percent annually.
- Comparison: other Western Balkan countries averaged 3.5 percent.
- Sub-periods:
  - Pre‑Global Financial Crisis: growth exceeded 5 percent in several years.
  - 2009–2019: economic activity moderated to about 2.4 percent.
  - 2021–2025: growth averaged about 3 percent.
- Demand-side contributions:
  - Private consumption contributed between 3.0 and 3.4 percentage points to GDP growth in pre‑GFC and post‑COVID periods.
  - Private investment contributed 1.4–1.7 percentage points across all periods.
  - Public consumption: modest contribution.
  - External sector: mostly negative contribution.
- Production-side dynamics:
  - 2001–2008: balanced gains from labor, capital, and TFP.
  - 2009–2019: TFP’s contribution turned negative; capital accumulation became more prominent.
  - 2021–2025: productivity accounted for the majority of output gains; labor contribution weakened and turned negative amid demographic aging and emigration.
- GDP per capita (PPP):
  - Nearly doubled since 2001; in 2024 it stood at 43 percent of the EU average.
  - Output per capita growth: around 3.0 percent per year (North Macedonia) vs. 3.7 percent for other Western Balkan countries.
  - “Half-life” of the income gap at current pace: almost 20 years.
- Labor supply outlook:
  - UN projections indicate continued emigration will shrink the working-age population, leading to a 0.5 percentage point decline in employment by 2030.

### B. Estimating potential output
- Definition: potential output = level of real GDP consistent with low and stable inflation (NAIRU-consistent), reflecting full and efficient utilization of labor, capital, and technology.
- Univariate filtering results (dual Hodrick–Prescott on annual and quarterly GDP from 2001):
  - Potential output growth averaged around 2.6–2.8 percent over 2001–2025.
  - Slowing from 3.4–4.0 percent before the global financial crisis to 2.3–2.4 percent in the subsequent decade (excluding 2020).
  - Pickup in potential growth in 2025 to about 2.6–2.7 percent.
  - Implied positive output gap in the range of 0.7–1.0 percent in 2025.
- Multivariate filtering models (Kalman filter; semi-structural New Keynesian design):
  - Annual model: reduced-form with unemployment dynamics and Okun’s law.
  - Quarterly model: Quarterly Projection Model (QPM) with more detailed supply side and monetary policy block.
  - Multivariate models broadly consistent with HP filter; point to somewhat larger positive output gaps in the most recent period.
  - Combined assessment: potential output growth in 2025 estimated at about 2.9 percent.
- Table summary (percent averages):
  - 2001-2008: HP Filter (Q Model) 4.0; Multivariate Filter (Q Model) 4.1; HP Filter (A Model) 3.3; Multivariate Filter (A Model) 3.4; Average 3.7
  - 2009-2019: 2.3; 2.2; 2.3; 2.4; Average 2.3
  - 2021-2025: 2.3; 2.5; 2.2; 2.4; Average 2.3
  - 2001-2025 1/: 2.8; 2.8; 2.6; 2.6; Average 2.7
  - 2025: 2.7; 3.4; 2.8; 2.6; Average 2.9
  - 1/ includes 2020

### C. Estimating the medium-term GDP impact of structural reforms
- Framework:
  - Frontier defined as average of the two best-performers among European economies and the United States, normalized to 100.
  - Benchmark assumption: North Macedonia closes 50 percent of its gap relative to the CESEE frontier.
  - Output Gains = Closed Policy Gaps * Output Elasticities (elasticities drawn from IMF and OECD studies; five-year horizon).
  - Caveats: aggregation assumes additivity across reform areas; may over- or under-estimate due to interactions, complementarities, and omitted indicators.
- Structural policy areas covered: governance; labor and human capital; business regulation; R&D and digitalization; credit and capital markets; external sector.
- Distance-to-frontier (2022): North Macedonia ranks below the 25th percentile and CESEE average in most areas except business regulation.
- Reform-specific estimated five-year gains (closing 50% of gap):
  - Labor market and human capital: total increase of 6.6 percent in GDP.
    - Closing labor force participation gap: 5.5 percent.
    - Closing human capital index gap: 1.1 percent.
  - Business environment (combined four areas: business regulation, R&D and digitalization, credit and capital markets, external sector): total increase of about 4.6 percent.
    - Lower external trade restrictions (MATR): 2.5 percent.
    - Improvements in product market regulations (PMR): 1.0 percent.
    - Deeper financial markets: 0.6 percent.
    - Higher business R&D spending: 0.5 percent.
  - Governance (proxied by control of corruption from WGI): 2.7 percent.
- Combined effect:
  - Cumulative medium-term output gains of about 14 percent from the selected reform package (roughly 2–3 percent additional annual growth, nearly doubling current estimates of potential growth).
  - Robustness checks re-weighting governance elasticities toward countries similar to North Macedonia yield results nearly identical to baseline.
  - External supporting evidence: World Bank (2025) simulations show medium-term gains of about 15 percent under narrower reforms.

### D. Role of the EU Reform and Growth Facility (RGF) and priority reform areas
- EU Growth Plan context:
  - World Bank estimates: full implementation of RGF reforms (closure of 70 percent of critical gaps with the EU in five key areas over 20 years) could boost baseline annual GDP per capita growth in Western Balkan countries by up to 3 percentage points.
  - Five priority areas under RGF: (i) digital infrastructure; (ii) regulatory quality; (iii) government effectiveness; (iv) financial development; (v) female labor force participation (LFP).
  - Largest estimated growth dividends under RGF: regulatory quality (1.13 pp), government effectiveness (0.95 pp), digitalization (0.63 pp); female LFP (0.35 pp); financial sector development (0.03 pp).
- RGF financing and progress for North Macedonia:
  - Eligible for up to €750 million in grants and favorably priced loans over 2024–2027, conditional on reform milestones.
  - As of latest assessment: completed 6 of the 50 steps (12 percent) and received €76 million, including €52.5 million in pre-financing.
  - Progress concentrated in: digital transition legislation; strengthening financial controls; SOE management (requirements for independent board members); labor and market inspections.
  - Pending milestones include: optimizing para-fiscal charges; establishing a comprehensive SOE register; advancing railways restructuring.
- Policy priority implications:
  - Labor market and human capital reforms, improvements in the business environment, and stronger governance (notably control of corruption) deliver the largest medium-term gains.
  - Governance reforms amplify payoffs from labor and business environment reforms; IMF (2019) finds gains from reforms can be more than twice as large in economies with strong governance compared with weak governance.
  - Sequencing and reform packages matter for maximizing and sustaining medium-term output gains.

*Source: IMF staff. sipea2026048 - 2.   Real GDP Growth Decompositions: Demand and Production Side (May 12, 2026).*

### 12.      This section translates the quantified growth payoffs into concrete and actionable

### 12.      This section translates the quantified growth payoffs into concrete and actionable

### Growth payoffs and reform priorities
- Closing 50 percent of reform gaps compared to the CESEE frontier could raise medium-term GDP by around 14 percent.
- Largest contributions to the 14 percent GDP gain are:
  - Labor markets and human capital: 6.6 percent
  - Business environment: 4.6 percent
  - Governance: 2.7 percent
- Priorities focus on the three high-return areas above and align with North Macedonia’s Reform Agenda supported by the EU Reform and Growth Facility (RGF).

### Labor market challenges and policy measures
- Supply-side gaps and constraints:
  - Female labor force participation remains approximately 20 percentage points below the EU average.
  - Youth unemployment is about 29 percent for those aged 15–24.
  - Persistently elevated rates of NEET (young people not in employment, education, or training).
  - Emigration projected to reduce employment by around 0.5 percentage points by 2030 (Ayerst and Kovachevska Stefanova, 2025).
  - Low adult participation in learning and training; vocational programs insufficiently aligned with employer needs.
- Demand-side constraints:
  - Labor productivity has risen by a cumulative 15 percent since 2019.
  - Post-pandemic annual productivity growth accelerated to around 5 percent.
  - Real wages have outpaced productivity, pushing the real wage–productivity ratio up by around 18 percent and eroding external competitiveness.
  - Collective wage-setting mechanisms in the public sector weakly linked to productivity.
  - Labor code broadly aligned with EU benchmarks (Annex II), but high informality and concentration of employment in low-productivity sectors persist.
- Policy recommendations to narrow gaps:
  - Expand affordable childcare and widen use of flexible work arrangements.
  - Strengthen activation and re-skilling programs; improve ALMP design and governance.
  - Increase adult-learning participation, strengthen vocational education and training, and enhance recognition of non-formal and informal learning.
  - Gradually increase the statutory retirement age for women to mitigate workforce losses from emigration and aging (Ayerst & Kovachevska Stefanova, 2025; IMF Article IV, 2025).
  - Lower the labor tax wedge to boost participation and reduce barriers to formal employment (IMF, European Department, 2024).

### Governance reforms
- IMF analysis: governance weaknesses—including corruption—materially impact macro-financial stability, investment, human capital accumulation, and total factor productivity.
- North Macedonia has almost halved its WGI-based governance gaps relative to economies that joined the EU since 2004 over the past 24 years, but progress is uneven, especially for the rule of law and corruption control.
- Priority governance measures:
  - Strengthen judicial independence and integrity through transparent, merit-based appointments; enhance accountability; ensure adequate staffing and resources; fully operationalize case management systems; implement the 2024–2028 Judicial Reform Strategy.
  - Adopt a new Criminal Code aligned with EU and international standards; improve the track record in high-level corruption cases via stronger financial investigation and confiscation tools.
  - Reinforce the capacity, independence and credibility of the State Commission for the Prevention of Corruption; improve effectiveness of asset and conflict of interests’ declarations.
  - Accelerate implementation of the national anti-corruption strategy; prepare a credible, well-prioritized updated 2026–2030 strategy with clear institutional responsibilities, sequencing, and adequate resourcing.
  - Strengthen coordination, data exchange and integrity systems across institutions responsible for prevention, detection, investigation, and prosecution of corruption.

### Business environment, investment policy, and formalization
- Key priorities to foster investment and competitiveness:
  - Strengthen transparency and digitalization.
  - Ease regulatory and financial constraints on SMEs.
  - Simplify licensing and permit procedures; streamline administrative, licensing, and registration fees.
  - Foster entrepreneurship and innovation; enhance integration in the EU internal market and alignment with EU legislation.
  - Strengthen internal trade policy by improving connectivity, promoting fair competition, transparency, consumer protection and legal certainty.
  - Promote formalization through strengthened tax compliance, and reduce regulatory delays and inconsistencies (Article IV, 2024).
- Investment and state aid:
  - Shift from a model centered on generous tax incentives and export-oriented FDI toward a broader competitiveness agenda with performance-based and EU-consistent state aid to strengthen linkages with domestic firms and support productivity.
  - Further tariff alignment with the EU and progress in customs efficiency to facilitate trade.

### Digitalization—public and private sector
- Public sector digitalization priorities:
  - Strengthen integrated e-government services and platforms; improve interoperability and data sharing.
  - Expand use of digital tools for more efficient and transparent service delivery.
  - Digitalize public financial management systems through IFMIS to enhance transparency, strengthen budget execution and capital projects oversight, improve compliance, lower costs, and improve revenue mobilization.
  - Address weaknesses in e-government strategy and coordination, architecture and infrastructure maturity, digital identity, signature and trust services.
- Private sector digitalization and skills:
  - Connectivity indicators: 91.2 percent of households have internet access and 89.2 percent daily users.
  - Digital skills gap: 28.5 percent of the population possess basic or average digital skills compared to the EU's 60.4 percent (Eurostat, 2026).
  - Priorities: national digital skills framework, targeted reskilling programs, strengthening digital capacities in the private sector, support for SME and startup digital adoption, improved access to finance, public‑private partnerships, coordinated donor support, transparent management of funds for business digital transformation.
  - Establish a flexible and robust legal and institutional framework for the safe and ethical use of AI; invest in talent attraction, research centers, and laboratories to strengthen competitiveness and align with EU standards.

### Building a cohesive reform roadmap
- Reform complementarities and sequencing:
  - Reform bundles outperform isolated actions; complementarities raise returns (IMF, 2019; Budina et al., 2023).
  - Examples: improved judicial efficiency enhances contract enforcement, lowers corruption, increases returns to human capital investment, and improves the business environment.
  - Digitalization raises productivity and reduces administrative burden, strengthening the business climate and fiscal management.
- Timing and political economy:
  - Reforms implemented in good times generate larger and faster output gains; easier implementation during periods of strong growth and favorable external conditions (IMF, 2019).
  - Political mandate and fiscal space reduce opposition and increase the effectiveness of reform compensation measures.
- Strategic sequencing:
  - Prioritize governance reforms early because they both generate direct growth gains and amplify impacts of labor market, business environment, and digital reforms.
  - With stronger governance, labor market, human capital and business-environment reforms can become the main engine of medium-term growth.
- Expected impact if implemented decisively and aligned with RGF milestones:
  - Sustain annual growth up to 2–3 percent higher than current potential, more rapidly narrowing the income gap with the EU.

*Source: IMF staff report section titled "12.      This section translates the quantified growth payoffs into concrete and actionable" from the provided PDF content.*

### 2.      The first model operates at a yearly frequency and is designed to estimate potential output

### 2.      The first model operates at a yearly frequency and is designed to estimate potential output 

### Model overview and objectives
- Designed to estimate potential output while accounting for labor market dynamics.
- Based on the multivariate filter framework outlined in Alichi et al. (2015).
- Reduced-form approach that simplifies DSGE dynamics into a tractable system suitable for empirical estimation with annual data.
- Treats potential output as a latent (unobserved) variable decomposed into trend and cyclical components.
- Uses a system of equations to filter trend and cycle from observable data: real GDP, CPI inflation, and the unemployment rate.
- Estimation relies on the Kalman filter in a Bayesian framework.
- Includes equations for forecasts (5-step ahead growth and inflation, derived from the IMF Staff macro-framework) to assist with end-of-sample identification.

### Key stochastic processes and equations
- Actual (log) output decomposition:
  - 푦푦ₜ  = 푦푦
푡푡
∗
+푦푦�
푡푡
- Potential output dynamics:
  - 푦푦
푡푡
∗
  = 푦푦
푡푡−1
∗
+  푔푔
푡푡
+  휂휂
푡푡
훾훾
- Growth rate of potential:
  - 푔푔ₜ  = (1−휃휃)·푔푔
∗
+휃휃·푔푔
푡푡−1
+  휂휂
푡푡
푔푔
- Output gap dynamics:
  - 푦푦�
푡푡
  = 휌휌·푦푦�
푡푡−1
+  휂휂
푡푡
푐푐
- Shock structure:
  - 휂휂
푡푡
훾훾, 휂휂
푡푡
푔푔, 휂휂
푡푡
푐푐 are mutually uncorrelated white-noise shocks.
  - Differentiates business cycle shocks (휂휂
푡푡
푐푐), shocks that permanently raise the level of potential (휂휂
푡푡
훾훾), and shocks to the growth rate of potential (휂휂
푡푡
푔푔).

### Inflation dynamics (Phillips Curve)
- Phillips Curve specification:
  - 휋휋ₜ  = 훼훼  + 훽훽·푦푦�ₜ  +휆휆·휋휋
푡푡−1
+ (1−휆휆)·퐸퐸
푡푡
휋휋
푡푡+1
+    휂휂
푡푡
휋휋
- Links evolution of inflation to:
  - Current output gap 푦푦�ₜ,
  - Backward-looking inflation 휋휋
푡푡−1,
  - Forward-looking expected inflation 퐸퐸
푡푡
휋휋
푡푡+1,
  - Inflation shock 휂휂
푡푡
휋휋.

### Labor market block and Okun’s law
- Unemployment gap definition:
  - 푢푢�
푡푡
=푢푢
푡푡
−푢푢
푡푡
∗
- Unemployment gap dynamics (Okun’s law and persistence):
  - 푢푢�
푡푡
  =휏휏
1
·푦푦�
푡푡
+휏휏
2
  ·푢푢�
푡푡−1
+  휂휂
푡푡
푢푢
- NAIRU dynamics and trend in NAIRU:
  - 푢푢
푡푡
∗
=
(1−휏휏
3
)
푢푢
푡푡−1
∗
+휏휏
3
푢푢
∗
+푔푔
푡푡
푢푢
∗
+휂휂
푡푡
푢푢
∗
  - 푔푔
푡푡
푢푢
∗
=
(1−휏휏
4
)
푔푔
푡푡−1
푢푢
∗
+휂휂
푡푡
푔푔
푢푢
∗
- Both the NAIRU and the unemployment gap are time varying and subject to white noise shocks; NAIRU also subject to persistent trend variations (푔푔
푡푡
푢푢
∗).

### Model outputs and uses
- Produces estimates of potential output, potential growth, and output gap at annual frequency.
- Incorporates labor market dynamics to relate output slack to unemployment gaps via Okun’s law.
- End-of-sample identification enhanced by including 5-step ahead growth and inflation forecasts from the IMF Staff macro-framework.

### Reduced-Form New Keynesian Model with Monetary Policy (quarterly QPM) — key features
- Operates at a quarterly frequency as a semi-structural reduced form New Keynesian macroeconomic model.
- Designed for coherent medium-term projections and monetary policy assessment.
- Links aggregate demand, inflation dynamics (sectoral hybrid Phillips curves), monetary policy, and the external sector.
- Includes identities and transformations to ensure internal consistency across national accounts, prices, and financial variables; parameters anchor steady state and medium- to long-run forecast path.

### Aggregate demand and real interest rate effects
- Aggregate demand specification:
  - 푦푦�
푡푡
=푏푏
1
푦푦�
푡푡−1
−푏푏
2
푚푚푚푚푖푖
푡푡
+푏푏
3
푦푦�
푡푡
∗
+휀휀
푡푡
푦푦
- Monetary stance and external conditions feed through:
  - 푚푚푚푚푖푖
푡푡
=푏푏
4
(푟푟̂
푡푡
+푚푚푟푟
푝푝푝푝푝푝 푚푚
푡푡
) + (1−푏푏
4
)(−푧푧̂
푡푡
)푚푚푚푚푖푖
푡푡

### Aggregate supply: sectoral hybrid Phillips curves
- Separate hybrid Phillips curves for:
  - Core price inflation (휋휋
푡푡
푐푐푐푐 푝푝푝푝),
  - Food price inflation (휋휋
푡푡
푓푓푐푐푐푐푓푓),
  - Energy/other price inflation (휋휋
푡푡
푝푝푒푒푝푝푝푝푔푔푦푦).
- Each curve includes:
  - Backward-looking component (lagged inflation),
  - Forward-looking expectations (퐸퐸
푡푡
휋휋
푡푡+1),
  - Dependence on sector-specific real marginal costs (driven by output gaps and sectoral factors, such as global prices).
- Representative equations:
  - 휋휋
푡푡
푐푐푐푐 푝푝푝푝
=푎푎
1
휋휋
푡푡−1
푐푐푐푐 푝푝푝푝
+ (1−푎푎
1
)퐸퐸
푡푡
휋휋
푡푡+1
푐푐푐푐푝푝푝푝
+푎푎
2
푟푟푚푚푚푚
푡푡
+휀휀
푡푡
푐푐푐푐 푝푝푝푝
  - Similar forms for 휋휋
푡푡
푓푓푐푐푐푐푓푓 and 휋휋
푡푡
푝푝푒푒푝푝푝푝푔푔푦푦, with sectoral coefficients a21, a22, a31, a32, etc.
- Aggregate inflation composition:
  - 휋휋
푡푡
=푤푤
푝푝푒푒푝푝푝푝푔푔푦푦
휋휋
푡푡
푝푝푒푒푝푝푝푝푔푔푦푦
+푤푤
푓푓푐푐푐푐푓푓
휋휋
푡푡
푓푓푐푐푐푓푓
+ (1−푤푤
푓푓푐푐푐푐푓푓
−푤푤
푝푝푒푒푝푝푝푝푔푔푦푦)휋휋
푡푡
푐푐푐푐 푝푝푝푝

### Monetary policy, exchange rate peg, and UIP
- Under North Macedonia’s fixed peg, the exchange rate serves as the nominal anchor, limiting monetary policy independence.
- Expected depreciation is zero, enforcing no-arbitrage.
- Domestic interest rates modeled using UIP:
  - 푖푖
푡푡
=푖푖
푡푡
∗
+푟푟푟푟푝푝푚푚
푡푡
+휀휀
푡푡
푠푠
- Risk premium specification:
  - Risk premium contains both a slow-moving trend and a gap component depending on:
    - Domestic and foreign output gaps,
    - Real exchange rate gaps,
    - Net foreign assets/GDP.
  - Ensures domestic rate shadows anchor country policy to prevent capital flows that could break the peg.
  - Representative decomposition:
    - 푟푟푟푟푝푝푚푚
푡푡
=푟푟푟푟푝푝푚푚
푡푡
���������+푟푟푟푟푝푝푚푚
푡푡
� 
    - Trend-gap dynamics for the risk premium trend:
      - 푟푟푟푟푝푝푚푚
푡푡
�=푚푚
1
푟푟푟푟푝푝푚푚
푡푡−1
�+(1−푚푚
1
)(−푚푚
2
푧푧̂
푡푡
+푚푚
3
푦푦�
푡푡
−푚푚
4
푦푦�
푡푡
∗
−푚푚
5
(�
푛푛푛푛푎푎
푦푦
�
푡푡
−�
푛푛푛푛푎푎
푦푦
�
��������
) +휀휀
푡푡
푝푝푝푝푝푝 푚푚

### Long-run real UIP and model consistency
- Long-run real UIP condition:
  - 훥훥푧푧̄
푡푡
=푟푟̄
푡푡
−푟푟̄
푡푡
∗
−푟푟푟푟푝푝푚푚
푡푡
���������
- Ensures consistency between trend real interest rates, the trend real exchange rate, and the country risk premium trend.
- QPM includes identities and parameter anchoring to generate internally coherent projections and evaluate alternative policy paths or shocks.

### Structural reforms: medium-term output effects (selected quantitative highlights)
- Annex III reports medium-term real GDP gains at the indicator level (approximate horizon: five years) and the elasticities used.
- Selected indicator elasticities and reported MT GDP effects (preserve formatting from source):
  - Labor force participation, total — World Bank; labor force as a share of the population aged 15 and above. 60.0% Labor Share of Income
  - Human capital index — United Nations Development Programme; higher values indicate stronger human capital. 9.4% Égert and Gal (2017) and Égert (2017)
  - Measure of aggregate trade restrictions — IMF; higher values indicate more restrictive trade regime. 0.9% Estefania-Flores et al. (2022)
  - Product market regulation (PMR) — OECD Product Market Regulation database, higher values indicate greater barriers. 2.5% Budina et al. (2023)
  - Business sector R&D as a % of GDP — OECD RDS; business-funded R&D expenditure as a share of GDP. 0.8% Égert and Gal (2017) and Égert (2017)
  - Financial markets depth — IMF; higher values indicate better performance. 3.5% International Monetary Fund (2019), Chapter 3
  - Governance — Control of corruption — World Bank, World Governance Indicators; higher values indicate less corruption. 3.6% Budina et al. (2023)
- Aggregate and area-level reported medium-term effects (preserve values as presented):
  - Labor market & human capital: 6.7%
  - Business environment: 4.6%
  - Labor force participation, total: 5.6%
  - Human capital index: 1.1%
  - Measure of aggregate trade restrictions: 2.5%
  - Product market regulation (PMR): 1.0%
  - Business R&D and digitalization: 0.5%
  - Financial markets depth: 0.6%
  - Governance — Control of corruption: 2.7%
  - Total effects: 14.0%

### Figures and data sources (not exhaustive)
- Annex I Figure 1: North Macedonia: Output, Potential Growth and Output Gap (Mil. Chn. 2005 Denars, percent). Notes state: "Sources: Haver Analytics and IMF staff estimates." and "1/ 100 time natural log of real GDP in Mil. Chn. 2005 Denars, seasonally adjusted."
- Annex II and Annex III draw on multiple external sources noted in the References (e.g., Fraser Institute; OECD; Berkeley; IMF; Eurostat; World Bank; WIPO; UNDP; Haver Analytics).

*Sources: Haver Analytics and IMF staff estimates.*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2026/english/sipea2026048.pdf_