Trade, Regional Integration and Growth in the Western Balkans Sanjay Kathuria Poverty Reduction and Economic Management Europe and Central Asia Region World Bank

Outline of presentation Macro performance Concerns about growth Role of exports Export performance: patterns Role of FDI What can be done to attract FDI? Consistency with Poverty Agenda

Macro performance Overall GDD growth is satisfactory, and improvements in Montenegro and FYRM in recent years Kosovo is an outlier for GDP per capita and poverty, and on other dimensions as well Serbia dominant economy in the region

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

And there are other important concerns Need to increase and sustain growth, given poverty and EU aspirations. But concerns on sustainability: TFP growth harder to achieve Trade preferences eroding (Bulgaria, Romania, multilateral liberalization) The CHINA factor Current account deficits: stability issue Exports well below potential and need Exports- low exports mean that the classic small country story not been played out, and hints at problems of competitiveness, which is not an easy fix, and hence raises sustainability concerns

Exports are critical for growth and current account sustainability Small countries need to trade more They also benefit more from trade In fact, growth has to be export-led EU integration also demands increased exports However, export performance, despite recent growth, is disappointing…

Aspects of 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 of goods and non-factor services. Variation from 22% for alb to 61% bulgaria Next slides focus on export patterns Merchandise trade deficit varies from 17 % (SaM) to 49 % of GDP (BiH) Under-trading relative to potential Per capita exports of goods and services very low indeed: US$ per capita exports from 584 (Albania) to 1236 (FYRM); Croatia 4206; Slovakia 5940; Turkey (much bigger) 1368 (all figures 2005)

Export Patterns: Focus on Low-skill and Natural Resource-Intensive Exports Wages are gross official wages in euros. Wages appear out of line with Skill Intensity of exports (2005) Slovakia very strong in high CI and SI (capital intensive and skill-intensive) Low wage segment: Bulgaria strong, and China, India, Bgldesh.

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 yet become part of the production supply chain: which is dynamic and fast-growing

FDI explains exports Serbia outlier in 2005 and so not included Exports to GDP (vert. axis) and FDI to GDP (horizontal axis) Explains export performance to a large extent and also performance in producer-driven supply chains

But what can be done about FDI? Countries are small. Why not invest in say Slovakia and within SEE in Croatia, Romania and Bulgaria? Until 2005, total FDI stock in Western Balkans (excl Croatia, 17 m popn.) was $ 11 billion FDI in Croatia (4.5 m popn.) $12.5 billion FDI in Slovakia (5.4 m popn.) $15.3 billion FDI is attracted by many factors, but crucial ones are a large domestic market, competitive human resources, and adequate infrastructure (and critical elements within that).

Move towards a Single Economic Space: Deeper Integration in SEE Deep integration: policies to reduce market segmentation (eg., customs clearance reqts., competition policy, FDI policy, sector-specific policies, barriers to trade in services, etc.) Major step forward: CEFTA 2006 signing: hence SEE as a whole is regional space But long road ahead: reducing border frictions, cumulation of rules of origin (CEFTA, then with EU), regional cooperation in services Benefits: more competition in the supply of goods and services, higher FDI (single market), and more intra-regional supply chains But this will not be enough to attract FDI– else all large middle income countries should see a lot of FDI

Human Capital Formation is Centerpiece Wages are out of line with pattern of exports (earlier table) Exchange rate arrangements do not allow much flexibility for most countries and high remittances add to pressure on ER Productivity improvement is thus critical 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 Very consistent with Poverty Agenda--Wkg. Poor

Energy : can be a Binding Constraint to Growth World over, electricity can be a binding constraint to growth: India, Bangladesh Business abhors unpredictability in critical inputs Electricity not a major issue in BEEPS 2005 except Albania (prob. for 57% firms). Albania lost upto 1 percent of GDP in 2005. FYRM also faced with problem last year Pre-empt regional energy shortages: the regional market is the optimal solution, will help to reduce volatility in supply as well as demand (and so help both producer and consumer)

Telecommunications: High Costs deter Integration and reduce potential gains Average costs of Skype call to Western Balkans (excl Croatia) is about 16 cents Western countries: 2.1c, Bulgaria, Croatia and Slovakia: 6.8 c ECA 18 country study (2007): within infrastructure, highest contribution to productivity from better telecom quality Application of telecom universal Potential payoffs to better connectivity and reduced costs very high, especially looking to deeper integration and supply chains within SEE

Sum-up: Policies to attract FDI, Increase Exports and position for future growth FDI is attracted by many factors, but crucial ones are a large domestic market, competitive human resources, and critical elements of infrastructure Deeper Integration and reduction of barriers thereof Human Skill formation Energy Telecom In many areas, incl. telecom, private sector will do the investment, but effective deregulation needed Deeper integration also within the three areas proposed above. This is agenda emerging from an ongoing study of SEE. These are broad contours emerging from the regional work, has to be complemented by in-depth country work. Not gone into how-to in these areas.

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 Alb, 46% FYRM), productivity of jobs is critical Human capital formation agenda outlined here: critical to sustained exports and growth Thus, another strong link between poverty and growth agenda