Until the strong impact of the global economic crisis, the Western Balkan countries registered relatively high growth rates, declining inflation, rapid expansion of foreign trade and increasing Foreign Direct Investment (FDI). Many important economic reforms, required by the transition to market economy, have also been implemented successfully. Ongoing political, legal and economic reforms, which were sustained by the EU Stabilization and Association Process (SAP), offered Western Balkan countries trade preferences, financial assistance (CARDS, IPA, IPA II), contractual relations through Stabilization and Association Agreements (which, by 2008, have been concluded with all countries, except Kosovo) and prospects of EU membership.
Despite the slowness of the political integration process – only Croatia has become an EU member – there is no doubt that EU measures have greatly contributed to economic integration of the Western Balkans into EU economy, since they stimulated trade, FDI, and banking and financial integration. The EU is the main trading partner of all Western Balkan countries, responsible for 60-75% of their merchandise trade (though for the EU, the region represents only 1.4% of its merchandise trade). Among the most important investors are companies that are prevalently from EU member states. Major EU banks own 75-95% of Western Balkan countries’ banking assets.
However, the global economic crisis has severely hit the Western Balkan economies from late 2008 onwards. All of the Western Balkan countries registered either negative GDP growth in 2009 or a substantial slowdown (Albania and Kosovo). The mild economic recovery in 2010-11 was interrupted by the sovereign debt crisis in the Eurozone, which directly contributed to a second recession in most Western Balkan countries in 2012-13. Therefore, despite EU policies having greatly facilitated the attainment of many important economic objectives, increasing EU-Balkan integration has rendered these economies much more vulnerable to external shocks. For the Western Balkans, integration with the EU proved to be a double-edged sword. During prosperous years it helped growth, economic recovery and integration into the global economy, but during years of crisis it pushed them into recession and instability.
The high degree of dependence on the EU economy suggests the factors that have made the Western Balkans vulnerable to the global economic crisis – trade openness, economic, financial and banking integration – are precisely those that will reinforce growth once the EU economy recovers more permanently. The problem is that the economic crisis in the EU has been much more profound and longer-lasting than expected. Still today there is great uncertainty regarding the right recipes. Moreover, the return of economic growth in the EU may not be enough to overcome the structural problems of the Western Balkan economies, which have been present long before the outbreak of the ongoing economic crisis. Not surprisingly, recent documents from the European Commission place strong emphasis on economic governance, and stress the importance of addressing the most pressing structural weaknesses of the Western Balkan economies.
Key structural problems
Four groups of structural problems should, in particular, be mentioned. First, the Western Balkans have been facing severe external imbalances. Although all of the countries have registered a remarkable increase in foreign trade during 2001-08, given that their products are still not sufficiently competitive on foreign markets, exports have often been half the volume of imports, causing high and rising trade deficits. The process of industrial restructuring has been slow, contributing to insufficient export growth and slow integration with the global economy. Thus, all countries except Macedonia, in 2012, still had exports of goods and services/GDP ratios below 50%. These ratios remain low in comparison with those of most of the Central East European (CEE) countries, who are, today, far more integrated into the global economy. The high trade deficits have contributed to rising current account deficits, which, until late 2008, were covered by substantial inflows of foreign capital (FDI, remittances, foreign loans, donors assistance), but have been drastically reduced after 2009. Strengthening external competitiveness remains the key priority, but this will require deeper restructuring of the real sector of the Western Balkan economies.
Second, despite relatively fast growth from 2001 to 2008, the Western Balkan countries have been facing serious labor market problems – high unemployment, very low employment rates, a flourishing informal sector – that have been causing mounting social problems. The new EU member states from CEE have also had problems of “jobless growth” in the 1990s – job creation has not been fast enough to absorb all people seeking employment – but, in the Western Balkans, this phenomenon has taken dramatic proportions. Unemployment rates today are over 30% in Macedonia and Kosovo, and above 20% in most other countries. Meanwhile, long-term and youth unemployment rates have reached alarming proportions. Employment rates in the Western Balkans remain below 50%, comparing rather unfavorably with the EU, where the current objective is to reach a 75% employment rate by 2020. The informal economy is still very diffused in all Western Balkan countries, preventing the collection of badly needed public revenues.
Third, the Western Balkan countries have experienced “premature” structural change, due to an extreme process of deindustrialization – a very fast expansion of services at the expense of industry and agriculture. Some deindustrialization took place in the whole transition region in the 1990s, since former socialist countries all had an oversized industrial sector, but in the Western Balkans the process continued also in the 2000s. A severe consequence of such structural change is the substantial decline of the share of tradable goods (mainly manufacturing products), further aggravating the problem of insufficient export growth and low competitiveness in world markets. Today the Western Balkan economies are characterized by a large service sector directed towards, primarily, the local market, and a very low share of manufacturing value added (in 2012 just over 12% on average for the seven countries), that is much lower than in many EU member states. The low share of manufacturing industry is also not in line with these countries’ present level of economic development. The structure of foreign investment has greatly contributed to such patterns of structural change, since around 2/3 of FDI has gone into non-tradable services – banking, telecommunications, retail trade, sometimes also real estate.
The last problem to be mentioned is that the process of the Western Balkans’ income convergence and catching up with the more developed EU has been extremely slow. With the exception of Croatia, the most developed country who joined the EU in July 2013, GDP per head (in Purchasing Power Standards – PPS) remains low: in 2013, it ranged from 21% in Kosovo to 42% in Montenegro of the EU average. Economic recovery has generally been slow. By 2008, three countries had still not reached their pre-transition (1989) levels of real GDP – Bosnia and Herzegovina, Montenegro and Serbia. After 2009, due to the double-dip recession, most countries have been pushed further back with respect to their pre-transition GDP.
These structural problems have not been caused by the global economic crisis, but have been accumulating for years. Their persistence illustrates how the process of relatively smooth transition in the CEE countries has not been replicated in the Western Balkan countries a decade later. A series of specific reasons has contributed to such unsatisfactory outcomes, including the unfortunate political events of the 1990s – disintegration of the Yugoslav federation, multiple military conflicts, severe international sanctions against FR Yugoslavia, the NATO intervention – that have also had very important economic implications. After a decade of high political and economic instability, the Western Balkan countries are, today, at a lower level of development. They have attracted less FDI, much later than the CEE countries, and predominantly in service industries. They are also less integrated with the EU and world economy. These are some of the reasons the Western Balkans, today, need additional instruments for a “big push”, to help them achieve more sustainable growth and faster economic development.
Policies to sustain economic development
There are several groups of policies that could contribute to a “big push” of Western Balkan economies, much more than they have done so far. The first is a more focused industrial policy.The key objectives of such an industrial policy would be to ensure some reindustrialization of the strongly de-industrialized Balkan economies. This could be done through measures that would facilitate the development of new industries and/or strengthen those sectors that, presently, contribute the largest part of exports. In many countries worldwide, governments have played a key role in inducing structural change, sector upgrading and economic diversification. In the Western Balkans, policy makers have excessively relied on foreign investors to carry forward these important objectives and have underestimated the importance of domestic policies. FDI has contributed to industrial restructuring of the Western Balkan economies only sporadically, and is unlikely to do so over the coming years. There are far fewer privatization opportunities in the Western Balkans today, than in the early 2000s. Meanwhile, FDI at the global scale has still not recovered to its pre-crisis levels. It is, therefore, the Western Balkan governments who will have to devise policies to restructure their economies, strengthen their tradable sectors and increase competitiveness on world markets. In order to implement a more efficient industrial policy, they could learn from current EU measures that aim at the reindustrialization of the EU economy. The Strategy for the Reindustrialization of Europe, launched in 2012, aims at increasing the share of manufacturing from the current 15% to 20% of GDP by 2020.
Another important group of policies regards investment in human capital. More efficient policies are needed to stimulate R&D and innovation, along with better quality reforms of the system of education, that are essential for reducing the present mismatch between demand and supply of specific labor skills. These policies are also closely related to the current EU objectives of a knowledge-based economy, that has had a fundamental role since the adoption of the Lisbon Strategy in 2000. Today, investing in human capital and the related objective of “knowledge-driven reindustrialization” is considered a key element for strengthening EU competitiveness. If these objectives are crucial for the EU, investing in knowledge and human capital is even more important for the Western Balkans, especially given their low level of economic development and insufficient competitiveness on world markets.
More intensive regional cooperation among the Western Balkan countries – including better coordination of national policies in various areas and implementation of regional initiatives – is another highly desirable priority for stimulating growth in the medium term. This is especially true given the small size of these economies and economic linkages inherited from the former Yugoslavia.
Although the benefits of regional cooperation have been emphasized for a long time, its potentials have not been sufficiently utilized. In addition to increasing intra-regional trade, which, for most Western Balkan countries, still remains quite important, other forms of regional economic cooperation could also contribute to growth in the areas of R&D, energy, transport or other specific industries. Industrial policies should also be considered at the regional level, through the creation of trans-national networks and supply chains that could be mutually beneficial. Multinational companies, created by enterprises from several Western Balkan countries, are bound to be more competitive on EU markets than small national firms. The SEE 2020 Strategy, adopted by the Regional Cooperation Council and the ministers of the respective Southeast European countries in Sarajevo in November 2013, will, hopefully, ensure the implementation of such regional cooperation initiatives.