How the Western Balkans can catch up

The six countries of the Western Balkans – Albania, Bosnia and Herzegovina, FYR Macedonia, Kosovo, Montenegro and Serbia – face a major convergence challenge vis-à-vis the EU in terms of living standards. GDP per capita in the Western Balkans is roughly half that of the 11 central and Eastern European EU countries (EU-11), one-third that of Southern EU members and a mere one-quarter of the richest EU members in Western Europe (Chart 1).

A new EBRD working paper examines how the Western Balkans can close this gap in the coming years by highlighting the scale of the challenge, the advantages of the region for investors and the likely growth drivers, as well as the challenges and risks. This focus piece summarises the main points of the paper.

    Chart1: Convergence potential

   Source: IMF WEO. Note: Countries are ordered from highest to lowest. Luxembourg excluded

1. How competitive is the Western Balkans relative to EU countries?

Western Balkan countries compare poorly with EU comparators on competitiveness measures; this is one of the main reasons behind the prosperity gap. The region’s average ranking is 86^th place in the World Economic Forum’s Global Competitiveness Report (GCR) in comparison to an average 36^th place for the EU (Chart 2). The failure to make efficient use of talent, the reliance on informal networks (i.e., family and friends) rather than on professional management, the lack of business sophistication, and inadequate transport infrastructure are among the main problems identified in the GCR.

But competitiveness is improving gradually. FYR Macedonia has experienced the biggest jump in its GCR score since 2007 and now ranks just behind the EU-11 average; notable advances have also occurred in Albania and Montenegro. In contrast, scores of the EU countries have remained on average almost the same as before. Governance scores are also improving (Chart 3), according to evidence from the World Bank. In an important sense, therefore, the region is converging towards the EU.

   Chart 2: WEF’s Global competitiveness Index        Chart 3: World Bank’s Governance Indicators

      Source: Authors’ calculations based on WEF’s Global Competitiveness Index and WB’s Governance indicatorsNote: Competitiveness score scale is [ 1, 7] and Governance     indicators scale is [-2.5, 2.5]. “EU-15” means the 15 members of the EU prior to the 2004 expansion.

2. What can the region offer to investors?

1. The region has an EU perspective. This is a unique quality in comparison to other emerging markets, as it helps to anchor market-oriented reforms and EU standards. However, full membership is not on the cards for any of the countries during the mandate of the present Commission (2014-2019).
2. The region enjoys a high degree of macroeconomic stability. Inflation is uniformly low and stable, and exchange rates are closely linked to the euro through fixed pegs or managed floats, or through unilateral euro adoption. Fiscal and current account deficits are more problematic in some cases but are being addressed, with several countries currently in programmes with the IMF.
3. Geographic proximity and tariff-free acess to EU markets is a strong advantage. China has recognised the importance of the region’s strategic location as a gateway to Europe in its “Belt and Road Initiative” and is planning to establish a rapid transport connection from the Greek port of Piraeus, the first major European container port for ships entering the Medditeranean from the Suez Channel, through the Balkans and further to EU markets – the “Balkan Silk Road”. The first operational move was made when the Chinese shipping giant Cosco Pacific took over half of the Piraeus port.
4. Economies in the Western Balkan region are quite diverse. As a result, they offer a wide range of opportunities for investors (Chart 4). “Domestic trade, transport and storage, accommodation and food services” is on average the largest sector of the Western Balkan economies, ranging from 18 per cent of value added in Albania and Serbia to 27 per cent in tourism-dependent Montenegro. Industry accounts for 20 per cent on average and varies significantly across the countries, with particular importance for Serbia. Agriculture also plays a vital role in the Western Balkans (12 per cent on average), both socially and in terms of employment.
5. Taxes and labour costs are also favourable. During the past decade, tax rates in the Western Balkans have been relatively stable and there has been a fall in the administrative burden of submitting taxes. Although there are differences among the countries in the region, the total tax burden is lower in all cases than in any of the EU benchmarks (Chart 5). In addition, all Western Balkan countries have lower Unit Labour Costs compared to the EU average (Chart 6). This is important for export-oriented companies specialised in labour-intensive industries. The advantage of low labour costs is complemented by the relatively educated population.

      Chart 4: Structure of economy, per cent of gross value added (2014)

     Source: National Statistical Offices.

5. Taxes and labour costs are also favourable. During the past decade, tax rates in the Western Balkans have been relatively stable and there has been a fall in the administrative burden of submitting taxes. Although there are differences among the countries in the region, the total tax burden is lower in all cases than in any of the EU benchmarks (Chart 5). In addition, all Western Balkan countries have lower Unit Labour Costs compared to the EU average (Chart 6). This is important for export-oriented companies specialised in labour-intensive industries. The advantage of low labour costs is complemented by the relatively educated population.

      Chart 5: Total tax burden as a % of profit (2015)       Chart 6: Unit labour cost (2014)