ECONOMIC AND FINANCIAL ANALYSIS

Third Education Sector Development Program (RRP CAM 43260) A. Economic Analysis 1. Economic Justification ECONOMIC AND FINANCIAL ANALYSIS 1. Economic benefits of basic education. In its National Strategic Development Plan, 2009 2013, the government reaffirms its high prioritization of, and commitment to strengthening the quality of education and enhancing equitable access to education for all Cambodian children who will be able to productively contribute to socio-economic development of Cambodia in the future. 1 The government commitment to universalizing basic education is premised on the recognized socioeconomic gains derived from increased quality education, which include improved health indicators and lower infant mortality, improved educational outcomes for future generations, higher economic productivity, a more responsive workforce that is able to support a diversifying economy, promoting social and cultural values, reducing fragility through strengthened social compacts between society and the state, and improved governance and accountability through increased capacity for civil and community engagement in governance systems. Each of these perceived benefits has a potential economic gain, as well as a potential gain in social capital. 2. The government aims to expand access expeditiously to improved quality of basic education, despite competing priorities for constrained public resources. The Third Education Sector Development Program is designed to support the Ministry of Education, Youth and Sports (MOEYS) and the government in responding to the challenge imposed by these constrained public resources by increasing MOEYS service efficiency while supporting expanded access to higher quality education services. The primary economic justification for the program is that it is an efficiency promoting program that will lower the total cost of producing grade 9 graduates each year to achieve an overall 19.5% reduction. This will be equivalent to an annual MOEYS recurrent budget saving of $16,091,742 per annum on present costs. Household costs of education in Cambodia are up to 20% greater than costs borne by MOEYS. The lowered cost of producing a grade 9 graduate will also result in recurrent savings at the household level. 3. Individual-level returns to education. Based on data from the Cambodia Socio- Economic Survey conducted in 2007, the wage returns on an additional year of schooling in Cambodia are 8.5% for men and 6% for women. 2 While the returns are comparable to overall international estimates of 4% 7%, 3 the returns for women counter international comparisons which find returns to be higher for women than for men. Gender parity in enrollments has been achieved at the primary and lower secondary levels. 4 Reaching parity is the first stage in progress toward gender equality in education. 5 Achieving gender equity in the formal education system is necessary to attain greater equality in employment opportunities. Choices in 1 Royal Government of Cambodia. 2009. National Strategic Development Plan 2009 2013.Phnom Penh: Council of Ministers. 2 Royal Government of Cambodia. 2007. Cambodia Socio-Economic Survey. Phnom Penh: National Institute of Statistics. It is speculated that the returns on education for women have decreased since 2004 because of the effects of the global economic crisis on the garment sector, which mainly employs women. 3 Basic Education Coalition. 2004. Teach A Child Transform A Nation. Washington, DC. Basic Education Coalition. 4 Parity is attained when the same proportion of males and females enter the education system. In Cambodia, the net enrollment ratio for primary education has reached 95% for both males and females. The total gross enrollment rate for lower secondary is 58% in total and 57% for females. 5 Equity is the process of treating males and females fairly. To ensure fairness, measures must be available to compensate for historical and social disadvantages that prevent males and females from operating on a level playing field.

2 employment for both men and women are shaped by their level of education. The gender gap in educational attainment strongly impacts women s opportunities for employment. 6 When they have a higher level of education, women can compete with men for employment. However, since few women are educated, only a small number are in a position to compete. The program aims to support MOEYS in addressing gender equality of lower secondary access and in the learning process toward achievement in the key areas of math and science that contribute to Cambodia s economic development. 4. Given the level of educational attainment and the structure of employment in the country, the quality of jobs created in Cambodia remains low. 7 Agriculture requires the least formal education, and pays the lowest hourly wages. Among waged employees, levels of education are higher in the public sector, but wages are higher in the private sector. Wage increases continue to be uneven. The rise in earnings has been greatest (90%) for households in the top 10% of the wealth distribution, but only 40% for those in the bottom 10%. While the returns to education are limited for the population as a whole, they appear significant for the wealthiest group. 8 Returns to education are high for those who have access to good quality educational opportunities. The program aims to support MOEYS in improving access to and quality of lower secondary education in some of the poorest provinces of Cambodia. 5. One of Cambodia s greatest challenges is to expand employment opportunities fast enough to absorb the 250,000 young people who reach working age and enter the labor market each year. Since 2000, employment has shifted from agriculture to the industrial and service sectors. Labor has migrated from rural areas where job opportunities are insufficient to cities where labor-intensive manufacturing and tourism-related services have been growing rapidly. In a recent survey, a majority of employers in business and industry reported that finding workers with a good work ethic and appropriate social behaviour was a primary concern. Most employers expect to train new employees in company-specific procedures and job-specific technical skills as well. However, they expect schools to take the responsibility for equipping young people with general employability skills. 9 The program will support MOEYS to integrate such employability skills into lower secondary education to prepare students for the future workplace. 2. Cost-Effectiveness Analysis 6. Repetition and dropout imply a very high level of wastage in education investments by the government and households. The program design will enable MOEYS to reduce repetition and dropout at the basic education level and ensure basic education completion in a costeffective way. Significant savings for households will also be achieved. The program includes a complementary policy program and investment project interventions that directly align with the Education Strategic Plan (ESP), 2009 2013, which sets the framework for meeting the goals set in the Education for All National Plan, 2003 2015. This approach is likely to be more effective 6 Royal Government of Cambodia. 2007. Cambodia Socio-Economic Survey. Phnom Penh: National Institute of Statistics. Among the population aged 15 64, more men than women completed lower secondary education (15% male vs. 9% female) and upper secondary education (6% male vs. 3% female). 7 International Labor Organization. 2006. Final Report: Informal Economy, Poverty, Employment in Cambodia, Mongolia, Thailand Good Practices and Lessons Learned: Geneva. Employment in Cambodia is characterized by a large proportion of the labor force that works in informal economic activities (either self-employed or working for nonregistered enterprises). Formal sector employment remains small. Paid employees account for only 25% of the workforce while the remainder is split between self-employment and unpaid family labor. The informal sector employs about 85% 95% of workers. 8 World Bank. 2009. Lessons from a Decade of Rapid Growth. Washington, DC. 9 Employability skills include basic skills, higher order thinking skills, and affective or soft skills.

3 and sustainable than project-based support focusing on narrow dimensions. In particular, the program tackles complex constraints to (i) expanded access to lower secondary education, (ii) improved lower secondary school efficiency and effectiveness, and (iii) improved governance and financial management of basic education. 7. Efficiency gains through the program. Projections based on present student progression and transition rates indicate that the numbers of students enrolled in primary, lower secondary, and upper secondary education will fall over 2011 2016, with primary education facing the steepest decline. This fall in student enrollment will be mirrored by a decrease in the number of students graduating from each subsector, with primary education facing the steepest decline. 10 This decline in graduate numbers will reduce the possibility of Cambodia reaching targets of the ESP, Cambodia Millennium Development Goals, and the National Strategic Development Plan. 8. The analysis also provides projections for the system under the program s policy reforms and project interventions, specifically those that aim to improve internal efficiency in primary and secondary education. 11 The potential impact of these proposed reforms is substantial. The following provides a brief analysis of the impacts leading to improvements in the effectiveness and efficiency of the system. 9. Reduced repetition rates leading to reduced dropout rates. Repetition rates are projected to be reduced by 56.85% for each grade at primary level and by 32.75% for each grade at lower secondary level. Significant reductions in repetition rates should directly lead to a reduction in dropout rates. To project the reduction in dropout rates, a number of research studies were reviewed. 12 Bernard et al found that an average 1% decrease in the repetition rate led to a 1.3% increase in the completion rate at later levels. Applying this to Cambodia means that a ceiling of a 3.0% repetition rate at the primary level would increase the primary completion rate from its present level of 62.55% to 67.69%. The reduction in repetition rates at the primary level reduces the average number of years it takes to complete primary education from 6.42 years to an average of 6.17 years. This should result in a lower average age of grade 7 entry and contribute to lower levels of dropout at lower secondary level. 13 10. Increased survival rates and number of grade 6 and 9 graduates. The projections indicate that the program s policy reforms and project interventions are likely to reverse the present downward trend in graduates and significantly increase the number of graduates at all levels. Survival rates (to graduation) will have increased by 11.4% at primary level, 21.6% at 10 Present projections, based on data from the MOEYS education management information system (EMIS) SY2010/2011, show that the number of grade 6 graduates is projected to fall from 242,016 in 2010 to about 221,002 by 2015 (9% decrease). Similarly, grade 9 graduates are projected to fall from 129,735 in 2010 to 111,535 by 2015 (14% decrease). The numbers of grade 12 graduates should benefit from recent improvements in grade 9 graduates and are projected to show some increase, reaching 88,835 by 2012. However, the present reductions in grade 9 graduates will begin to have an impact and this number is projected to decrease to 72,982 by 2015 (2% decrease). 11 Under the program, MOEYS will (i) establish the Primary Lower Secondary Progression Program focused on improved student engagement at the primary level and dropout prevention at the lower secondary level, and (ii) introduce and enforce a maximum repetition rate of 3% in complete primary schools and 1% in lower secondary schools. 12 S Ndaruhutse et al. 2008. Grade Repetition in Primary Schools in Sub-Saharan Africa: an evidence base for change. Berkshire, UK. CfBT Education Trust. ; J-M Bernard, O. Simon, and K. Vianou. 2005. Le Redoublement: Mirage de l Ecole Africaine? Programme d analyse des systèmes éducatifs de la CONFEMEN. CONFEMEN. Dakar; J-M Bernard, O. Simon, and K. Vianou. 2002 2005. African Region Human Development Working Papers: 19, 35, 78, 90, 100, Various Countries: World Bank. 13 Under present conditions, the average number of years of lower secondary school attendance is 1.91 years for a student at risk of dropping out. Upon analysis of the cohort model, this should increase to 2.16 years under the program leading to lower secondary completers.

4 lower secondary level, and 35.5% for basic education. The average number of years per completer will decrease by 10.3% at primary level, 14.0% at lower secondary level, and 23.8% for basic education. By 2016, over 42,000 more students are projected to graduate primary education, and nearly 35,000 more students are projected to graduate lower secondary education. Each graduate will cost significantly less than students graduating at present. The overall cost per completer will fall by $38.23 at primary level, $78.24 at lower secondary level, and $287.97 for basic education. These efficiency gains represent very significant improvements on the present system (Tables 1 and 2). Table 1: Projected Increase in Grade 6 and 9 Graduates Absolute Improvement School Year Beginning 2011 2012 2013 2014 2015 2016 Grade 6 graduates 7,059 13,974 19,447 26,611 32,284 42,419 Grade 9 graduates 12,104 16,462 24,826 28,344 32,783 34,895 Percentage Improvement School Year Beginning 2011 2012 2013 2014 2015 2016 Grade 6 graduates 2.91% 5.64% 8.13% 11.03% 13.70% 19.19% Grade 9 graduates 10.18% 14.42% 22.02% 25.08% 28.47% 31.29% Source: MOEYS Education Management Information System and TA7657-CAM: Third Education Sector Development Program Table 2: Projected Efficiency Gains Key Indicator Subsector Present situation Primary Lower Basic Secondary Education Total cost per graduate (incurred within the subsector) $372.26 $559.14 $1,358.74 Probability a new entrant will graduate (survival rate) 55.2% 51.2% 25.7% Projections based on the introduction of this program Primary Lower Basic Secondary Education Total cost per graduate (incurred within the subsector) $334.03 $480.89 $1,070.77 Probability a new entrant will graduate (survival rate) 61.4% 62.24% 34.8% Comparative impact of the program Primary Lower Basic Secondary Education Actual reduction in total cost per graduate (within the subsector) $38.23 $78.24 $287.97 Percentage reduction in total cost per graduate (within the subsector) 10.27% 13.99% 21.19% Percentage improvement in survival rate to graduation 11.4% 21.6% 35.5% Source: MOEYS Education Management Information System and TA7657-CAM: Third Education Sector Development Program 11. Recurrent cost saving. At present, MOEYS is required to spend $1,358.74 of public funding to produce a basic education graduate. In 2010, 129,735 students graduated at an estimated total cost of $176,276,191. 14 The cost per basic education graduate should fall to $1,070.70 under the program s policy reforms and project interventions aimed at reducing repetition and dropout rates. It is projected that, there will be 146,449 basic education graduates in 2016 at a total estimated cost of $160,184,449. MOEYS implementation of the program 14 All figures are based on 2011 costs. Future increased salary costs will inflate all figures at the same rate.

5 should result in a recurrent cost saving of $16,091,742 per annum by school year (SY) 2015/2016. 12. Recurrent budget savings resulting from the program s policy reforms and project interventions will accumulate with each child as they pass through each year of education and will increase annually, which will be fully realized once an entire cohort has passed through the basic education system in 9 10 years. However, by SY2015/2016, MOEYS will be benefiting from a reduced recurrent budget requirement of $1.5 million. Students graduating in this year will have spent most of their education in the present, less cost-effective system, so the savings accrued will be proportionally smaller. Conversely, MOEYS would require a recurrent budget allocation of $198,986,798 to achieve the same 146,449 grade 9 graduates by 2016 under the present, less cost-effective system. This is a cost of $38.8 million more than with support from the program. 13. Other design aspects. Other design features that are cost-effective and/or have prospects to enhance the efficiency of the basic education system include (i) policy actions for directing resources to schools to meet local needs; and (ii) project interventions for building school director capacity for developing and implementing the school-based enrichment program (SBEP), addressing issues affecting students at risk of dropping out, and the pilot testing of school improvement grants (SIGs) to support implementation of the SBEP in select schools of target provinces. 14. In line with the Ministry of Economy and Finance (MEF) public financial management reforms, MOEYS has developed a strategic program to improve the cost-efficiency of the services it provides by directing resources to schools to meet local needs. Part and parcel of this program is the introduction of school operating budgets (SOBs) for all primary, lower secondary, and upper secondary schools, funded through the national recurrent budget. Under the program, MOEYS will be supported to engage in policy actions to revise the SOB funding mechanism to make provision for school improvement block grants, which will support student progression and completion. Complementary project interventions aligned to this will be (i) capacity development for school directors to develop and implement the SBEP, and (ii) SIGs to support SBEP implementation in select schools of targeted provinces. School directors will gain the skills and knowledge for identifying at-risk students, planning interventions to support student retention, and engaging teachers and school support committees to work together in addressing issues affecting students at risk of dropping out. Experiences from the SBEP, supported by SIGs, will justify provision for school improvement block grants to support student progression and completion. 15. Geographic targeting. As well as wider national benefits highlighted above, the program will assist MOEYS in achieving improved equity of service delivery a critical objective of public service delivery systems. In this respect, the program has a specific focus on the Tonle Sap and border provinces. These provinces exhibit higher average dropout rates and lower completion rates for lower secondary schools than the national average, and perhaps not coincidentally lower than average gross domestic product (GDP) per capita. Given their significantly lower base of educational performance, the targeting of these areas is expected to reap higher returns in respect of program impact while supporting MOEYS pro-poor and equity agendas.

6 3. Beneficiary Analysis 16. The program is expected to benefit (i) about 376,500 lower secondary school children a year in 14 target provinces through investments in civil works, training, and capacity building; (ii) about 100,000 children who are at risk of dropping out of lower secondary school each year; (iii) about 560,000 lower secondary school children nationwide who will benefit each year from improved math and science instruction, and better managed and better financed schools; and (iv) grade 6 graduates in 141 communes who will have improved access to lower secondary school. The improved student progression rates achieved through the program s policy reforms and the improved quality of education supported through the project interventions will enable and encourage greater student retention and progression through the education process. The program is anticipated to result in significant improvements in graduation rates (paras. 9 10). Moreover, the improved quality of lower secondary education should support increased productivity and employability of grade 9 graduates, which may lead to a potential stimulus for increased foreign investment and economic diversification. B. Financial Analysis 1. Macroeconomic Context 17. Economic growth has continued for Cambodia. Figures from the Supreme National Economic Council show an average annual increase in GDP of 4.7% over 2007 2010, and a projected average increase of 6.6% over 2011 2014. These increases are reflected in the level of GDP per capita, which increased by a total of 26.4% over 2007 2010 and is projected to increase a further 34.3% over 2010 2014. While the impact of the global economic crisis was evident in 2009, subsequent years and present projections indicate that Cambodia s limited exposure to global financial markets and the government s continued application of sound fiscal policies appear to provide a sound buffer against further significant downturns. 15 18. Since the 1990s, increasing political stability, continued economic liberalization, and macroeconomic stability have contributed to Cambodia achieving impressive levels of annual growth. Since 2005, rapid growth in the banking and financial services sector has enhanced opportunities for increasing both national and foreign direct investment (FDI). At present, FDI focuses mainly on garments, tourism, and real estate. Incremental improvements in the physical, legislative, and financial infrastructure, combined with significant natural resources (particularly oil and gas), appear to offer significant potential for further increases in both national and FDI over the medium term. However, the availability of a sufficiently skilled workforce is a critical factor that may govern the realization of increased external investment. 2. Education Sector Finance 19. Recent trends and present projections of government recurrent budget indicate a positive trend. Over 2007 2011, government recurrent budgets have increased by an overall 86.9% 16 and are projected to increase a further 25.7% over 2011 2014. Similarly, the MOEYS budget has increased by an overall 88.2% over 2007 2011 2 and is projected to increase a further 84.3% over 2011 2014. This equates to an overall 30.0% increase in the projected purchasing power of the MOEYS budget while accounting for projected inflation rates over 2011 2014. 15 World Bank. 2009. Lessons from a Decade of Rapid Growth. Washington, DC.. 16 Note that 2007 2010 are budget expenditures and 2011 is budget allocation.

Percentage of GDP 7 20. Projected increases in the percentage of government recurrent budget allocated to MOEYS appear favorable, reaching 19.8% of government recurrent budgets in 2014 and 2.10% of GDP. These increases are compounded by projected increases in GDP (Figure 3). Figure 3: Ministry of Education, Youth and Sports Recurrent Budget Trend (%) 2.5% MoEYS Recurrent Budget as % of GDP and RGoC Recurrent Budget 2007-14 25% 2.0% 1.5% 16.52% 1.64% 1.45% 1.40% 13.67% 14.90% 15.47% 1.80% 1.78% 16.64% 1.94% 2.02% 17.26% 18.16% 2.10% 19.77% 20% 15% 1.0% 10% 0.5% 5% 0.0% 2007 2008 2009 2010 2011e 2012p 2013p 2014p Financial Year 0% MoEYS Budget as % of GDP MoEYS Budget as % of RGoC Budget GDP = gross domestic product; MOEYS = Ministry of Education, Youth and Sports; RGoC = Royal Government of Cambodia Source: MoEYS data 3. Sustainability of Program Investments 21. Policy reforms and project interventions, specifically those that aim to improve internal efficiency in primary and secondary education, are likely to create recurrent budget savings. The trend in the projected MOEYS recurrent budget indicates sufficient resources for sustaining the positive outcomes envisaged under the program. Additionally, the adoption of a revised funding formula for SOBs to increase the overall budget allocations to schools will sustain efforts toward improved student progression and completion rates. Sustainability and its degree of impact will be dependent on the level of increase in funding per student provided through this mechanism. To assess the feasibility of sustaining this program, SIGs will be pilot tested in selected schools of target provinces to develop and implement school-based enrichment programs. For the purposes of this analysis, a benchmark increase in SOBs of $1.00 per primary school student and $1.50 per lower secondary school student was used. This represents an increase of about 39% on present allocations to each primary school student and an increase of 30% on present allocations to each lower secondary school student. 17 22. The following provides a summary of the potential recurrent resource requirement beyond program implementation. Activities related to promoting the value of basic education and piloting of SIGs are discrete activities to be carried out during implementation of the 17 The average SOBs in SY2010 2011 were $2.54 per primary school student and $5.04 per lower secondary school student.

8 program, so no recurrent costs are likely to be incurred after program implementation. Recurrent costs related to the implementation of activities strengthening math and science education, introducing employability skills program, strengthening school director professional development, and strengthening school support committees beyond the program implementation time frame will be covered by the program-based budget. For civil works activities, the bulk of expenditure is the initial capital outlay financed under the program. However, once constructed, the facilities will require maintenance. The SOB and similar operating budgets for the Regional Teacher Training Centers (RTTC) are designed to cover the cost of basic maintenance for school buildings, latrines, and associated physical facilities. Development of basic education school clusters is a pilot program, so the relative impact and cost of nationalizing such an approach will be reviewed during program implementation. At present, it is budgeted at $547,000 for implementation in two provinces. The majority of the cost is associated with technical advisory costs. It is expected that the cost of national implementation of basic education school clusters will be significantly lower. Potential costs of national implementation would be capital rather than recurrent and may be accessible through funds from MOEYS Capacity Development Partnership Fund (CDPF). 18 Activities related to the introduction of action research for policy development will provide MOEYS with the resources to conduct its own research, in line with the technical focus of the program, to respond to emerging challenges in sector performance in a more effective manner. About $65,000 has been allocated per year to this activity. If the approach proves to be effective, it is envisaged that a budget code will be established for the sustainable financing of this activity through MOEYS systems, with potential additional funding being provided through MOEYS CDPF. 4. Systemic Efficiency Gains 23. The efficiency gains of the program represent very significant improvements on the present system. Table 4 provides a summary of the efficiency gains. Costs incurred within the subsector Table 4: Projected Efficiency Gains Present System Lower Basic Primary Primary Secondary Education Reformed System Lower Secondary Basic Education Student Survival Rate 55.2% 51.2% 25.7% 61.4% 62.2% 34.8% Years of input per graduate 9.3 4.9 24.9 8.4 4.2 19.0 Total MOEYS cost per graduate a 372.26 559.14 1,358.74 342.38 489.16 1,093.79 MOEYS = Ministry of Education, Youth and Sports. a Including costs of increasing school operating budgets by an additional $1.00 per primary school student and $1.50 per lower secondary school student. Source: MOEYS Education Management Information System and TA7657-CAM: Third Education Sector Development Program 18 A pooled funding mechanism supported by development partners.