How Can the Small Countries in the Western Balkans Continue to Grow?

Sanjay KathuriaLead Economist

Europe and Central Asia Region, World BankJuly 2008

Outline of presentation Export-led growth imperative But exports and growth demand skills This makes FDI important- as well as

skills What will bring in FDI? Messages

Regional Integration Re-prioritization of some elements of the

national investment climates

Selected Indicators for Western Balkans

  Alb BH Cro fYRM Mont. Serbia

Population (millions) 3.2 3.8 4.5 2.1 0.6 7.5

Poverty rate (%, 2005) 25.4 17.8 4.0 22.0 10.4 9.4

GDP (billion current $) 9.1 12.9 42.6 6.2 2.4 31.6

GDP per capita (US$) 2,830 3,290 9,580 3,050 3,760 4,220

Growth Appears Healthy in 2007

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Albania BiH

Bulgar

ia

Croat

ia

FYRM

Romania

Serbia

Slovakia

But growth not as good as other regions (2000-06 average)

0123456789

WBalkans Baltics E Asia S Asia

And Sustainability Concerns Productivity growth harder to

achieve Trade preferences eroding The China factor: Middle Income

Trap Current account deficits: stability

issue; exports key But exports well below potential

and need

Exports are also critical for growth

Small countries need to trade more, and benefit more from trade

In fact, growth has to be export-led EU integration demands increased

exports Thus, exports crucial for both macro

stability and growth However, export performance, is

largely disappointing…

Disappointing export performance

Poor export performance Low skill-based exports But wages out of line with such export

patterns And not an important part of

producer-driven supply chains Hence, concerns on sustainability of

exports

Poor Export Performance

•

BCR vs Balkans: Exports/GDP

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

1 2

Series1

Exports as a Share of GDP

Exports, GNFS (% GDP, 2006)

0.0

20.0

40.0

60.0

80.0

100.0

Alban

ia BiH

Bulgar

ia

Croat

ia

FYRM

Romani

a

Serbi

a

Slova

kia

%

Export Patterns: Low Skills, High Wages

Capital Intensive Official wage

and Skill Intensive

Albania 10.9 161

BiH 33.2 420

FYRM 35.2 343

SaM 46.8 326

Bulgaria 34.2 161

Croatia 39.3 841

Slovakia 71.0 296

Wages cause for concern Maybe not high on average relative to most

of EU8 and Europe BiH has higher wages; Albania low; others

vary according to data source Even Albania and Bulgaria high vs. China,

India and B’desh (so exports vulnerable) Reducing tax wedge to make labor more

competitive can help (FYRM starting) But in medium-term, only way out is to

improve productivity

Participation in producer networks low

Changes over 1996-2005 (percentage of manufactured exports in parts and components):

SEE-- 6% to 11% EU8-- 14% to 19% Slovakia-- 13% to 21%Except Romania and Croatia (much lesser

extent), SEE not part of the dynamic production supply chain

FDI important for exports and growth

•

Per capita FDI stock very low: Albania 603, BiH 676, Serbia 1119, Croatia 4577 euros per capita stands out. EU8 countries at least 3-4 times.

FDI critical for technology and exports But need domestic skills and

motivation for technology absorption

But what can be done about FDI? Countries are small. Why not invest in Slovakia and

Croatia, Romania and Bulgaria? Stock of FDI (2005)

Western Balkans (except Croatia, 17 m popn.) $ 11 billion

Croatia (4.5 m popn.) $12.5 billion Slovakia (5.4 m popn.) $15.3 billion

Policy Agenda Context Small countries Not taken advantage of openness and

export-led growth FDI performance: stock and pattern Skill formation has big gaps Countries not integrated enough to function

as one market Overall record on exports therefore not

surprising How to get out of the ‘Middle Income Trap’?

Deeper Integration in SEE- Goods and Services

Reduce market segmentation Major step forward: CEFTA 2006 But long road ahead:

reducing border frictions; CEFTA rules of origin; regional cooperation in services.

EU MFN rates will reduce trade diversion Benefits: more competition in supply of

goods and services, higher FDI (single market) and intra-regional supply chains

Deeper Integration in SEE- Labor

Will need an agreement on movement of skilled labor

Can be done bilaterally to begin with Mutual recognition of professional

qualifications and educational institutions

Temporary worker agreements Return migration programs can help in

skill formation Cooperation in education- specialization

Human Capital Formation is Centerpiece of Economic Strategy Solution for relatively high wages:

Productivity improvement Reduce tax wedge for labor

Human capital needs major thrust in region: gestation lags; poor education outcomes; enable move to more skill-intensive exports and attract FDI; skills constraint in BEEPS 2005

Costs of Skype Calls (EUR cents)fixed-line mobile

Macedonia 17.6 29.6Bosnia and Herzegovina 16.5 24.6Albania 13.7 16.2Montenegro 9.3 20.9Serbia 9.3 20.9Bulgaria 5.5 21.5Slovenia 5.2 23.9Croatia 4.3 17.9EU-15 1.7 -

Telecommunications: High Costs deter Integration and reduce potential gains

ECA 18 country study (2007): within infrastructure, highest contribution to productivity from better telecom quality

Application of telecoms universal Potential payoffs to better connectivity

and reduced costs very high: including deeper integration and supply chains within SEE; enabling small firms to overcome handicaps of size; and overall productivity

Energy : can be a Binding Constraint to Growth World over, electricity can be a binding

constraint to growth: India, Bangladesh Electricity not a major issue in BEEPS

2005 except Albania (problem for 57% firms).

FYR Macedonia going through adjustment process now

Pre-empt regional energy shortages: the regional market optimal solution, will help to reduce volatility in supply as well as demand

Sum-up: Policies to attract FDI, Increase Exports and Position for Future Growth

FDI : domestic market size, human resources, and elements of infrastructure

Some areas not given due policy attention Deeper Integration and reduction of

barriers thereof Human capital formation: education, return

migration, regional market for skilled labor (and reduce tax wedge)

Energy: regional market Telecoms: competition, regulatory capacity

Poverty Agenda Growth poverty link: demonstrated world

over. Poverty reduction in region demands continued growth.

Given very large shares of working poor in Balkans (eg, 61% of poor in Albania, 46% FYRM), productivity of jobs is critical

Human capital formation agenda outlined here: critical to sustained exports and growth

National/Regional Policy Change

Policy examination of priorities needed at country level, followed by action

Deeper Integration, for goods and services at regional level

Same messages in other countries in the region, including on regional integration

Regional integration needs coordinated action by countries and leadership in CEFTA, for example

Report Recommendations and BiH

Export level in BiH is lower than regional average, trade imbalance very high

SAA and CEFTA provide opportunities for export growth, but structural and business environment reforms necessary to fully exploit new opportunities:

Reform priorities for BiH to boost export growth Enhance labor competitiveness:

reduce social contributions (FBiH in particular), contain wage growth in public sector, invest in human capital (improve efficiency of education spending)

Reduce regulatory burden to doing business: Facilitate business entry and exit, reduce cost of

regulatory compliance

Restructure public expenditures and increase their efficiency: Increase levels and efficiency of public investment,

increase efficiency of education expenditures, better target social assistance