How Can the Small Countries in the Western Balkans Continue to Grow? Sanjay Kathuria Lead Economist Europe and Central Asia Region, World Bank July 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 AlbBHCrofYRMMont.Serbia Population (millions) Poverty rate (%, 2005) GDP (billion current $) GDP per capita (US$)2,8303,2909,5803,0503,7604,220

Growth Appears Healthy in 2007

But growth not as good as other regions ( average)

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

Exports as a Share of GDP

Export Patterns: Low Skills, High Wages

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 (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)

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