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

2. 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

3. 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

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

5. 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

6. 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…

7. 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

8. 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)

9. 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.

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

11. 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

12. 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).

13. 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

14. 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

15. 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 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)

16. 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

17. 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.

18. 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