**1.** **<u>Introduction</u>**

# **_(i) Country Context_**<sup>_1_</sup>

1. Since independence, Timor-Leste (TL) has confronted a range of social and economic challenges.  Some are related to the economic volatility common to post-conflict countries as reconstruction-related spending rises rapidly and then subsides (though it has performed well in comparison to other post-conflict countries).  Some relate to the challenges of establishing institutional and governance structures in a newly independent state with low human capital endowments.  Others relate to the efforts of a resource-dependent state to diversify its sources of production and employment.  Finally, Timor Leste is a very poor country, with per capita GDP in 2004 of only US$366.  The challenges to develop a broad-based and sustainable pattern of growth are made more pressing by a high population growth rate and the need for employment of a young population.

2. This report focuses on urban labor markets in Timor-Leste. As in any economy, labor market outcomes are a result of many influences, both inside and outside the labor market itself. Factors outside the LM can include macroeconomic policies, political stability, the business climate, demographics, and the education and training systems. These factors produce a mix of supply and demand side influences on the LM which feed into employment outcomes. They are also likely to have major impacts on the composition of employment between the formal and informal sectors. Promoting employment growth – preferably in the formal sector - is therefore not simply a matter of having employment-friendly labor market policies, but of having the appropriate mix of macro and microeconomic policies. Even with a sensible mix of policies, open economies – particularly small open economies with heavy dependence on a sectorally narrow production base - will remain vulnerable to exogenous shocks. However, many of the employment-promoting policies that make sense in the absence of shocks can be even more important when shocks hit in terms of how rapidly the economy is able to adjust to shocks. This section looks at some of the key developments and policies in Timor-Leste outside the LM in order to provide context to the detailed discussion of urban LMs in the main part of the paper.

3. The growth path of Timor Leste in recent years has been volatile, with both strong positive and negative shocks to the economy in a short period. Violence in 1999 resulted in a sharp drop in non-petroleum GDP, by around 35 percent. This was followed in 2000 and 2001 by high growth of 15 and 17 percent respectively as massive foreign reconstruction aid came in, reaching US$ 300 per capita in FY02. The boom years were followed by a strong demand shock in 2002 and 2003 as GDP declined 6 percent in each year, before recovery in 2004 on the back of new petroleum production. However, despite renewed growth, GDP per capita has declined in the face of a high population growth rate. These macroeconomic developments are likely to have had significant impacts on the labor market, both in terms of uncertainty and in terms of geographical concentration in and around Dili of growth even in the periods of positive shocks. Despite the challenging situation, the Government has exercised prudent macroeconomic management.

4. TL is, and is likely to remain for the foreseeable future, a highly rural economy. Poverty is also higher in rural areas, with around 45 percent of the population below the poverty line in 2000, against around 25 percent in urban areas. Productivity in rural areas is also low,

> 1 This section draws on the Timor-Leste Country Assistance Strategy (2005) and the Timor-Leste Business Climate Assessment.

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