1. Overview: Identifying strategic opportunities for the Western Balkans
The Western Balkans have come a long way over the last two decades. Similar historical development patterns, have endowed the region’s economies with the relatively solid infrastructure, industrial experience and a skills base and academic tradition that can be levers of future development. Developing the region’s potential will require new sources of dynamism and transformation to overcome deep-seated social, institutional and environmental challenges. This chapter takes a holistic view of the region’s development performance across a range of outcomes, spanning the breadth of the Sustainable Development Goals. It then draws on the remaining chapters in this part to outline strategic priorities to build on the Western Balkans’ assets and address the key constraints they face.
The Western Balkans have come a long way over the last two decades. Current population of the Western Balkans is about 17.6 million. Today, the six economies (Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia and Serbia) have a combined gross domestic product (GDP) of close to USD 309 billion (in purchasing power parity [PPP] terms) – up from 106 billion in 2000, which represents 1.5% of the European Union’s GDP. The region’s average GDP per capita is about USD 17 000 (PPP) in 2021, having nearly tripled from USD 6 000 (PPP) in 2000 (Figure 1.1 – Panel A).
The region’s location and deep relationships with Europe and many parts of the world present multiple opportunities. Similar historical development patterns have endowed the region’s economies with the relatively solid infrastructure, industrial experience and a skills base and academic tradition that can be levers of future development. Economies of the region have deep relationships with many parts of Europe and the world as a result of recent migration flows and centuries of being at the crossroads of South East Europe. As geographical distance seems to shrink with digitalisation, these relationships can be leveraged for further dynamic development. At the same time, geographical proximity to important European markets and production networks offers economic opportunity, if the appropriate skills, infrastructure and business environments can be provided. Further EU integration is a central driver of many of the region’s opportunities.
Integration into the European Union (EU) is a central strategic objective for the region and an opportunity to accelerate reform processes in the Western Balkans. The process towards integration with the EU has been an important driver of democratisation, peace and institution building in the Western Balkans and has provided the region with large financial and technical support for its development and regional integration. Through the Stabilisation and Association Process (SAP) since 1999, the economies in the region have been involved in a progressive partnership with the European Union. The new Enlargement Package and the adoption of the Economic and Investment Plan have set new directions for EU integration and recovery from COVID-19 (Box 1.1).
The process towards integration with the European Union has been an important driver of democratisation and institution building in the Western Balkans and has provided the region with large financial and technical support for its development and regional integration. As part of the process, the regional economies have worked to bring their legislation in line with the EU acquis. Currently, Albania, Montenegro, North Macedonia and Serbia are candidates for integration, while Bosnia and Herzegovina and Kosovo are potential candidates.
The Stabilisation and Association Process (SAP) rests on the following pillars: bilateral Stabilisation and Association Agreements (SAA); trade relations (wide-ranging trade agreements); financial assistance (the Instrument for Pre-accession Assistance [IPA]); and regional co-operation, such as the Central European Free Trade Agreement (CEFTA).
The first SAA of the region entered into force in North Macedonia (2004), followed by Croatia (2005, which then concluded its process of integration in 2013), Albania (2009), Montenegro (2010), Serbia (2013), Bosnia and Herzegovina (2015) and Kosovo (2016). The agreement offers various benefits to citizens and business (such as visa-free travel), supporting institutional and democratic reforms, and encouraging neighbourly relations and trade (European Commission, 2020[1]).
The IPA has been instrumental in providing the region assistance in reforms through financial and technical help. In the period 2014-20 IPA II funding ranged from 3.3% of GDP in Bosnia and Herzegovina to 9.2% of GDP in Kosovo (European Commission, 2020[2]).
The new Enlargement Package and the adoption of the Economic and Investment Plan have set new directions for EU integration and recovery from COVID-19. Building on the Western Balkan strategy from 2018 (European Commission, 2018[3]), the Enlargement Package adopted on 6 October 2020 stresses the need to improve the EU integration process to be better equipped to deal with structural weaknesses in the Western Balkan economies. In parallel, the European Commission adopted the Economic and Investment Plan to spur the long-term economic recovery of the region, support a green and digital transition and foster regional integration into and convergence with the European Union. The support is crucial, especially in light of both the COVID-19 impact and the existing challenges, such as weak competitiveness and high unemployment. The plan will mobilise up to EUR 9 billion of IPA III funding for 2021-27. A large majority of this support will be directed towards key productive investments and sustainable infrastructure in the Western Balkans through the ten flagship initiatives. Through the Western Balkans Guarantee facility, the ambition is to raise additional investments of up to EUR 20 billion (European Commission, 2020[4]; European Commission, 2020[5]).
Note: The ten flagship investment initiatives are: two transport infrastructure projects (connecting east to west and north to south), renewable energy, transition from coal, connecting coastal regions, building renovations, waste and water management, digital infrastructure, supporting the competitiveness of the private sector, and youth support.
Source: European Commission (2020[1]; 2020[2]; 2020[4]; 2020[5]; 2018[3]).
Developing the region’s potential will require new sources of dynamism and transformation to overcome deep-seated social, institutional and environmental challenges. In the decade leading up to the global financial crisis in 2008, most regional economies experienced dynamic growth and financial sector expansion. However, the crisis was followed by a much more subdued economic rhythm and the rate of growth has not been sufficient to achieve convergence towards the EU and the OECD averages in per capita terms (Figure 1.1 – Panel A). Labour markets have performed poorly, with among the highest non-participation rates in the world, but have finally found an increasing trend in recent years (Figure 1.1 – Panel C) (IMF, 2021[6]). While emigration eases employment pressures and generates remittances that aid social welfare, it results in brain drain and ageing societies. Inefficient public spending often drives poor education results and insufficient social safety nets. Heavy dependence on coal and other environmentally unstainable practices are the drivers behind high air pollution and increasing CO2 emissions, both with important negative impact on people’s well-being and health (Figure 1.1 – Panel B). Last, formal rules are often at odds with informal practices. The power of networks and weaknesses in governance and institutions must be addressed.
Notes: Costa Rica officially became an OECD Member on 25 May 2021, therefore it is not included in the OECD averages in the current report.
Source: IMF (2021[6]), World Economic Outlook Databases, https://www.imf.org/en/Publications/SPROLLs/world-economic-outlook-databases#sort=%40imfdate%20descending.
The COVID-19 pandemic will pose a huge additional challenge for the region for the foreseeable future, making reflection and strategic action urgent. Many economies in the region have experienced economic slowdown, while continued global uncertainty weighs both on the region and on its trading partners and sources of investment and remittances. Overall, the region has managed an effective response. However, a return to more stringent measures resulting from a resurgence in cases and climbing death rates threatens the region's outlook. As the countercyclical imperative will necessitate large-scale public spending, strategic questions become more urgent than ever to ensure that resources are well spent. Given the likely size of the spending, missed opportunities will be much more costly than they would be otherwise.
The Multi-dimensional Review (MDR) of the Western Balkans aims to support the region and its economies to learn with each other and develop strategies for action. The project consists of two reports and multiple peer learning events across the region. This report provides a regional overview and assessments of the five participating economies (Albania, Bosnia and Herzegovina, Kosovo, North Macedonia and Serbia) across the economic, social, finance, governance and environmental pillars of Sustainable Development. The objectives of this report are twofold: first, to identify strategic priorities of relevance for the whole region as the focus for peer learning; and second, to serve as inputs for the national development strategies and plans currently under development in the region, as well as for the region’s many co-operation partners as they devise their support.
This overview chapter summarises the main results of the initial assessments and suggests strategic priorities for the region. First, it presents inputs for statements of development visions for 2030 elaborated by participants of strategic visioning workshops conducted in Albania, Kosovo, North Macedonia and Serbia.1 Second, it presents key trends for the region that any future strategy must take into account. Third, it takes a bird’s-eye view to assess the region’s development performance on the basis of key statistics on well-being and summarises the major constraints to development identified through multi-dimensional analysis. It concludes by suggesting key strategic directions for the future.
Whenever relevant and subject to data availability, the Western Balkan economies are compared with three groups of benchmark economies: 1) Organisation for Economic Co-operation and Development (OECD) countries (Costa Rica, Czech Republic, Greece, Slovak Republic, Slovenia and Turkey); 2) non-OECD EU countries (Croatia and Romania); and 3) countries in neither the OECD nor the European Union (Kazakhstan, Morocco, Philippines and Uruguay). The selection of benchmark economies is based on historical similarities, including their paths towards EU integration, and on economic structures, geographical proximity and mutual partnerships. The selection of non-OECD economies is based on similar economic and social challenges (such as high migration rates), shared history as transition economies and similar development patterns. Such a broad set of benchmark economies can bring an additional perspective to the Western Balkan economies and create valuable learning opportunities across selected policy dimensions (Table 1.1).
Subsequent phases of the project focus on peer learning and generating ideas for action on shared opportunities and challenges. Peer-learning events in early 2021 convened representatives of the participating economies and OECD and other international experts to generate knowledge and ideas for solutions. The events focused on shared challenges and opportunities identified on the basis of the present report, the accompanying initial assessments and the discussions in a series of informal meetings of the Mutual Learning Group of members of the OECD Development Centre.
A vision of a desired future is an important input for identifying opportunities and devising strategy. It should provide a description of what citizens hope for in terms of the economy, society, institutions and the environment. Based on the most important desired elements in each domain, vision statements can be formed and obstacles identified. Four Vision and Challenges 2030 workshops were held as part of the MDR (Box 1.2). The workshops gathered a range of participants from various ministries and agencies, the private sector, academia and civil society. Narratives of the lives of future citizens were the basis for vision development.
Despite their anticipated diversity, all future narratives highlighted aspirations for broad economic opportunity and good quality of life, health, education, employment and environmental quality. Most narratives of the lives of future citizens focused on young people, especially women, with higher education – some in high-skilled professions, such as engineering and entrepreneurship. Many have returned with experiences from abroad and are exploring opportunities at home. All have middle-class family lives, decent, stable work, good health and access to quality education. They have houses and enjoy leisure time in green, clean public spaces. Good-quality public services and an economic environment conducive to starting a company and improving skills for career development are also emphasised.
Strong education, good governance and the rule of law, a clean environment and dynamic economies offering opportunities emerge as the main elements of desired futures (Figure 1.2). Following the formulation of narratives and vision statements, workshop participants voted on the most important dimensions of a positive future. With impressive unanimity, quality education ranked topmost in all workshops. Rule of law and quality public services are also very important to citizens, especially in Albania, Kosovo and North Macedonia, indicating the importance of strong institutions. In Kosovo, North Macedonia and Serbia, access to, and quality of, health services rank very high. Reflecting differences in development across geographical areas, decentralisation ranks high for citizens in Serbia. Access to quality jobs and environmental considerations are also important.
As part of the MDR process, Vision and Challenges 2030 workshops took place in Albania, Kosovo, North Macedonia and Serbia between February and early March 2020. All workshops followed the same methodology and aimed at developing suggestions for a vision 2030, including vision statements, key dimensions of success and challenges. Workshops were jointly organised by the OECD, the Swedish International Development Cooperation Agency and government representatives.
The workshops brought together between 30 and 60 stakeholders representing different perspectives (government, academia, the private sector and civil society) and consisted of four sessions: 1) “Postcards from the future” was a storytelling exercise in which participants developed a fictitious 2030 citizen and described his or her life in a scenario of the economy’s successful development. On the basis of these stories, participants identified the key dimensions of future success along the five pillars of sustainable development, then voted to determine the most important dimensions (Figure 1.2). 2) “Vision Statement” was based on the earlier session. Participants developed a vision statement reflecting the desired future and development goals. 3) “Key priorities and challenges for the future” focused on the present with the desired future in mind. Participants discussed and voted on the key challenges a 2030 strategy must address. 4) “Trends and global environment” focused on local, regional and global trends affecting development opportunities and strategy.
As all workshops followed the same methodology, results can be easily compared and help highlight many of the desires and challenges shared across the region.
This section presents four important regional and international trends likely to impact the Western Balkans in the near to medium future. These trends have been identified on the basis of horizon-scanning exercises during the visioning workshops and their relevance and potential impact. Together with the visions, these trends will form the foundation for the multidimensional constraints assessment and the identification of strategic opportunities.
Rapid population ageing
The rapid ageing of societies across the region will be a major challenge for achieving further increases in living standards and ensuring the financial sustainability of public social expenditure. Driven by low fertility rates and high migration abroad, the number of those with age 65 or above per those of working age (20-64) is expected to more than double by 2050. Population ageing may lead to the loss of human capital and is already putting considerable pressure on the financial sustainability of social security system in the region, especially on pension expenditures. In addition, medical expenses tend to rise steeply at older ages (Figure 1.3).
Note: Western Balkan average includes Albania, Bosnia and Herzegovina, Montenegro, North Macedonia and Serbia. Costa Rica officially became an OECD Member on 25 May 2021, therefore it is not included in the OECD averages in the current report.
Source: United Nations (2020[8]), “World Population Prospects 2019”, https://population.un.org/wpp/.
Climate change
The Western Balkans are highly prone to climate change and vulnerable to extreme weather events. According to projections, the region will face rises in temperature and changes in precipitation patterns, leading to increased flood risk, extended periods of drought, soil erosion and forest fires (Table 1.2). Some of the regional economies, especially North Macedonia and Bosnia and Herzegovina have suffered rather significant losses due to extreme weather events in recent years (Figure 1.4). Considering that a high percentage of population is employed in sectors, such as agriculture, tourism and forestry, the Western Balkan region is particularly exposed. The floods in 2014 demonstrated that the region was not prepared nor adequately equipped to deal with the increasing dangers posed by climate-related impacts (ICUN, 2020[9]). In 2017, the region witnessed record temperatures, which caused a drought in Serbia and a drop in agriculture output of nearly 10 %, and forced Albania to spend EUR 200 million on energy imports (World Bank, 2018[10]). Climate change impacts may have a significant impact on society (drinking water deficit, migrations, and heat stress) and economy (disruption of food production, irrigation, and hydropower production).
Source: Data.World (2021[12]), Climate Risk Index, https://data.world/gpsdd/e1dcef1d-b9ca-4c22-8b78-f7b6703d2274 (accessed on 15 March 2021).
Democratisation process
The halting democratisation process in the Western Balkans in recent years has been eroding people’s trust in public institutions. Despite the immense success in democratisation and the build-up of democratic institutions since the start of the political and economic transition in early 1990s, the democratisation process seems to have stalled over the last decade (Figure 1.5). Frequent political changes and political instability, distrust in the electoral processes and their frequency, party fragmentation and other factors have contributed to this trend. If this trends continues, this is likely to further erode citizens trust in institutions, increase migration, affect the EU integration process and the quality of institutions, which in turn may also affect business environment, education and other areas that drive development.
Source: Bertelsmann Foundation (2020[13]), BTI Transformation Index (database), https://www.bti-project.org/en/data.
Digital transformation
Digital transformation is an opportunity for the Western Balkans to address some of the structural political, social, economic challenges, and to get ready for the expected changes in the labour market in the near future. The latest OECD research suggests that, should current cutting-edge technology become widespread, 32% of current jobs across the 32 countries analysed are likely to see significant changes in how they are carried out and a further 14% of jobs could be completely automated (OECD, 2019[14]). Although the percentage of individuals using Internet in Western Balkans has increased significantly in the last decade, it still remains below the EU (80.8%) and the OECD average (84.7%) (Figure 1.6 – panel A). At the same time, the Western Balkan region still has a relatively low share of individuals with basic or above basic skills (Figure 1.6 – panel B). The COVID-19 pandemic offers an opportunity to increase the penetration of digital technologies to households and businesses, to increase digital skills of people, to strengthen e-government, to integrate previously marginalised population groups into the economy, and to prepare the citizens for the future changes in the labour market.
Note: Panel A – no data for Kosovo. Panel B – no data for Albania and Montenegro.
Source: ITU (2020[15]), International Telecommunication Union – Telecommunication Development Sector (ITU-D) (database), https://www.itu.int/en/ITU-D/Statistics/Pages/default.aspx; Eurostat (2018[16]), Eurostat (database), https://ec.europa.eu/eurostat/data/database.
Building on the visions and trends, well-being around the world and sustainable development as benchmarks, this section reviews the development performance of the Western Balkans. The proposed inputs for visions emphasise well-being, strong institutions, access to opportunity, gender equality and sustainable development as the ultimate objectives of development. To assess the well-being of the Western Balkan economies, the OECD’s Well-being Framework uses a mix of objective and subjective indicators across a range of dimensions that matter to people (OECD, 2020[17]) (Box 1.3). A version adapted to the realities of emerging economies compares the Western Balkans to the level of well-being outcomes expected, given its level of GDP per capita, in ten dimensions covering material conditions, quality of life and quality of relationships. In a second step, this section assesses the Western Balkans’ performance for the five pillars of the sustainable development goals, applying distance-to-target measures across a selection of indicators and building on the analysis in the main body of this report and on other regional assessments, including OECD (OECD, 2018[18]) and European Commission assessments (European Commission, 2019[19]; European Commission, 2019[20]; European Commission, 2020[21]).
Well-being
In terms of well-being, the Western Balkan region’s performance reflects its level of development and shows room for improvement. Overall performance is close to what benchmarking suggests for the region’s level of GDP per capita (Figure 1.7). Improving well-being will require significant efforts. Citizens across the region feel comparatively safe and are not exposed to violence and crime to the same extent as those in other benchmark economies of similar income status. Poverty rates are relatively low, and life expectancy is high. However, work, empowerment and life satisfaction stand out as underperforming compared to benchmarks. Employment rates (42.7%, on average, in 2019) are very low, and low performance on corruption and on voicing opinions to officials point to a weak link between states and citizens. This is also reflected in the low rates of satisfaction with public services, such as health, roads and education.
Notes: The observed values falling inside the black circle indicate areas where the Western Balkans perform poorly in terms of what might be expected from a country with a similar level of GDP per capita. Expected well-being values (the black circle) are calculated using bivariate regressions of various well-being outcomes on GDP, using a cross-country dataset of around 150 economies with a population of over one million. All indicators are normalised in terms of standard deviations across the panel.
Sources: Gallup (2020[22]), "Gallup World Poll”, www.gallup.com/analytics/318875/global-research.aspx; ILO (2020[23]), ILOStat (database), https://ilostat.ilo.org/data/; OECD (2020[24]), OECD PISA database, www.oecd.org/pisa/data/; Transparency International (2019[25]), Corruption Perceptions Index 2019 (database), www.transparency.org/en/cpi/2019/; UNESCO (2019[26]), “UNESCO Institute for Statistics”, http://uis.unesco.org/; World Bank (2020[7]), World Development Indicators (database), https://databank.worldbank.org/source/world-development-indicators; WHO (2020[27]), Global Health Observatory (database), www.who.int/data/gho/data/countries.
As part of its broader Better Life Initiative, the OECD first created its Framework for Measuring Well-being in 2011 with the aim of putting people at the heart of policy making. This represented the culmination of longstanding work both inside and outside the organisation. Important strides to “go beyond GDP” had been made with United Nations Development Programme’s Human Development Index and the work on multi-dimensional poverty by the Oxford Poverty and Human Development Initiative. The framework also draws on rich academic literatures in welfare economics and capability theory, the recommendations of the Commission on the Measurement of Economic Performance and Social Progress (Stiglitz, Sen and Fitoussi, 2009[28]) and existing well-being and sustainable development measurement practice in OECD member and non-member countries. Since its launch, the work on well-being has continuously been updated in line with best practice and continues to be published in the OECD’s How’s Life? report series (OECD, 2020[17]). For the purpose of the MDR, the OECD Well-being Framework has been adapted to fit the realities of countries at different stages of development (Boarini, Kolev and McGregor, 2014[29]).
The adapted OECD Well-being Framework used in this report focuses on living conditions at the individual, household and community levels that capture how people experience their lives “here and now”. Current well-being here is comprised of ten dimensions related to material conditions that shape people’s economic options (Income, Housing and infrastructure, Work and job quality) and quality-of-life factors that encompass how well people are (and how well they feel they are), what they know and can do, and how healthy and safe their places of living are (Health, Education and skills, Environmental quality, Life evaluation, Security). Quality of life also encompasses people’s connectedness and engagement (Social connections, Empowerment).
Methodological considerations
To capture the full range of people’s actual life experiences, the OECD Well-being Framework uses both objective and subjective indicators. For instance, the Health dimension not only looks at life expectancy estimations but also considers how people feel about their health status and the health services they are receiving. Subjective indicators are sometimes viewed as not being as robust as objective measures; however, there are at least three reasons for considering them alongside the latter to get a holistic picture of well-being. First, there is solid methodological evidence that the subjective measures contained in the well-being framework (e.g. life satisfaction, trust in others and government) are statistically valid and correlate with objective measures of the same construct (OECD, 2017[30]). Second, even in cases where perceptions diverge from objective reality, they capture the reality of survey respondents and can drive real-world outcomes, such as voting and lifestyle behaviours (Murtin, Fleischer and Siegerink, 2018[31]). It can actually be especially insightful for policy makers to zoom in on areas where the gap between citizen perception and objective indicators is largest. Third, many of the measures typically considered objective and routinely used in policy analysis, such as household income, are based on people’s self-reports and can equally be affected by response biases and non-response rates (e.g. of very wealthy households).
There are significant differences in well-being between men and women in the Western Balkans, and this report finds that there is scope to improve women’s equal participation in society (Figure 1.8). As in most countries around the world, women in the Western Balkans have higher life expectancy and life satisfaction than men (OECD, 2020[17]). Men do much better in terms of work. There are significant differences in labour market participation: 40% of women participated in 2019, one of the lowest rates among benchmark countries. Gender gaps in formal employment are particularly high for women of childbearing age. The lack of early childhood education (ECE) facilities often acts as a burden for women in addition to slow school-to-work transition, full-time household activities and cultural norms that encourage traditional division of labour.
Note: Well-being outcomes for women are represented by circles; men’s outcomes are represented by bars. The observed values falling inside the central black circle indicate areas where the Western Balkans performs poorly in terms of what might be expected from a country with a similar level of GDP per capita. Expected well-being values (the black circle) are calculated using bivariate regressions of various well-being outcomes on GDP per capita, using a cross-country dataset of around 150 economies with a population of over one million. All indicators are normalised in terms of standard deviations across the panel.
Sources: Gallup (2020[22]), "Gallup World Poll”, www.gallup.com/analytics/318875/global-research.aspx; ILO (2020[23]), ILOStat (database), https://ilostat.ilo.org/data/; OECD (2020[24]), OECD PISA database, www.oecd.org/pisa/data/; Transparency International (2019[25]), Corruption Perceptions Index 2019 (database), www.transparency.org/en/cpi/2019/; UNESCO (2019[26]), “UNESCO Institute for Statistics”, http://uis.unesco.org/; World Bank (2020[7]), World Development Indicators (database), https://databank.worldbank.org/source/world-development-indicators; WHO (2020[27]), Global Health Observatory (database), www.who.int/data/gho/data/countries.
Major constraints to sustainable development
Based on multi-dimensional analysis, this section summarises the major constraints to sustainable development identified along the five pillars of the Agenda for Sustainable Development: People, Prosperity, Partnerships and financing, Peace and institutions, and Planet.
People
Despite the financial crunch COVID-19 will present, Western Balkan societies cannot afford to miss opportunities for investment in their human capital and for generating equal opportunities for all. Although living standards have improved in recent decades, poverty and lack of access to infrastructure continue to affect citizens, especially ethnic minorities and those living in rural areas. There are not enough jobs, particularly in the formal sector, and high youth unemployment rates are pushing the young to migrate. Across countries, women’s low participation in paid work due to full-time household chores, lack of child and elderly care services and cultural norms that encourage traditional division of labour is striking. Public services in the region do not live up to their potential: besides the need to develop future-proof education systems in the face of subpar learning outcomes, health and social protection infrastructure needs to be better resourced and modernised, more efficiently organised and made more inclusive of those most in need. Particularly in a context of high informality, the current model of financing social protection largely from social security contributions needs to be revised.
Prosperity
The growth of Western Balkan economies has slowed considerably over the past decade as domestic demand has moderated and export-led growth has been mitigated by weak competitiveness. The period saw a significant decline in productivity growth, as productivity-enhancing labour reallocation between sectors and between firms has been limited and within-sector productivity growth has slowed. A significant share of investment has gone into the non-tradable sectors or sectors with limited productivity-enhancing potential, while in economies that have attracted notable export-oriented foreign direct investment (FDI), limited integration between the FDI sector and the domestic economy has constrained economy-wide productivity gains and structural transformation. Competitiveness is also undermined by weaknesses in human and physical capital. Human capital development is constrained by weak education quality and a mismatch between labour market needs and the qualifications and skills produced by the education system. The underdeveloped physical infrastructure suffers from underinvestment and lack of maintenance by largely inefficient state-owned enterprises (SOEs) and from underutilisation of private-sector investment or operational potential. Unfavourable institutional and business environments hinder the growth and internationalisation of small and medium-sized enterprises (SMEs). Key challenges include pervasive corruption, weak contract enforcement and unfair competition from SEOs or from firms that shirk the rules on taxes and social contributions. Weak access to bank financing and underdeveloped non-bank financing also constrain SMEs, particularly start-ups and microenterprises.
Partnerships and financing
In light of weak domestic savings, most Western Balkan economies rely strongly on external financing for growth. The region benefits from considerably higher inflows of remittances, official development assistance (ODA) and FDI than global peers, even if some of these sources of financing have declined in recent years, compensated for in part by rising external debt. FDI in the financial sector has been an important driver of credit expansion over the past two decades, alongside the rise in domestic deposits. However, credit growth over the past decade in most regional economies has been driven by household and government lending. Enterprise lending has been more subdued, reflecting higher non-performing loans in this sector and tighter lending standards by the bank sector. Bank lending has been particularly constrained for micro and small enterprises and start-ups, which have difficulty meeting banks’ stringent collateral and other requirements but have limited alternative financing options due to underdeveloped non-bank financing.
Most regional governments are not highly indebted, but public debt has increased across the region over the past decade, and the COVID-19 crisis has recently taken a big toll on public finances. The rise in public debt was driven by expansionary fiscal policy in the aftermath of the global financial crisis, but it also reflects structural constraints, namely weak revenue performance accompanied by high and rising current expenditures. On the revenue side, the relative underperformance of most regional economies mainly reflects high informality and high tax avoidance through under-reporting of sales, wages, etc. In some economies, it also reflects significant tax incentives for investment and employment, as well as low tax rates. On the expenditure side, high and rising current expenditures have put significant pressure on public finances across the region. They mainly reflect high and rising pension expenditures across the region. In some economies, they also reflect generous subsidies for employment, high benefits for war veterans and high wages for public-sector employees.
Peace and institutions
Throughout the past decade, Western Balkan economies have made institutional improvements. The prospect of EU accession has been pivotal in driving change and pushing governments to align legislative frameworks to the EU acquis. While citizen trust in government remains low, it has increased in some economies. Informal institutions continue to play a key role in settling disputes when court proceedings are lengthy and costly, but overall, the judiciary in the region has strengthened. Through power-sharing arrangements, ethnic groups have a chance to take part in decision-making processes. Old grievances still exist but do not trigger large-scale conflicts like 20 years ago. However, this is not enough; much more has to be achieved to strengthen institutional fundamentals, restore a durable social contract and improve people’s well-being.
Reviewing the role of the state in people’s lives and the economy can open up opportunities across the region. State structures are often overly complex: numerous ministries and agencies and unclear lines of accountability, for example, delay decisions and cost time and resources. Property rights are not always secure, undermining investments and dampening trust in formal institutions. The balance of power between central and local governments has not yet reached a stable arrangement. Peripheral localities often have few resources to catch up and offer credible alternatives to capitals or outmigration. Public resources are not always allocated efficiently but rather according to political interests. Politics continue to play too great a role in the functioning of the public administration and SOEs, which are sometimes inefficient and capture markets, preventing innovation and productivity gains.
Overall, democratic values need strengthening. Patronage and clientelism (and at times ethnic outbidding) risk undermining democracy. As a result, some parliaments are very fragmented and have difficulty agreeing on policies. Political debates has become so acrimonious that some leaders have boycotted elections and allowed the monopolisation of institutions by one party. Either way, the legislative is often too weak to ensure checks and balances on the executive. A still too-frail judiciary cannot play this role either. Citizens place the rule of law, good governance and effective policy making very high in their visions of a good future. Coming together around this objective can lead to paths towards new opportunities for development.
Planet
The Western Balkans have rich biodiversity. Between 28% (Albania) and 61% (Montenegro) of economies’ territory is covered by forests. Across the region, the forest sector makes an important contribution to the economy and could be further exploited. Western Balkan economies should make the most of their rich biodiversity by minimising degradation, better preserving resources and enhancing well-being and quality of life for all.
Western Balkan economies have high levels of air, water and ambient pollution and face important challenges in their energy sectors. Levels of air pollution in Western Balkan economies are the highest in Europe, and economic and health costs from air pollution are high. The main sources are the residential sector, poorly insulated buildings, electricity generation from coal and the transport sector. Inadequate management and treatment of solid waste and wastewater cause ambient and water pollution and pose a threat to human health. In the energy sector, except for Albania, Western Balkan economies rely heavily on highly polluting coal for electricity generation. Levels of energy intensity are high, and outdated energy infrastructure and unreliable electricity supply are key challenges. Public utility tariffs set below operational costs limit financial resources available for investments in the energy sector, solid waste and wastewater management and water supply. Water management, water scarcity and natural hazards are challenges in several Western Balkan economies.
Like most of Europe, the Western Balkans experienced two surges of COVID-19 since the onset of the pandemic (Figure 1.9). With 2 789 registered deaths per million inhabitants by 24 May 2021, Bosnia and Herzegovina has been hardest hit in the region. Albania had consistently the lowest number of cases and registered deaths in the region, standing at 850 of registered deaths per million as of end of May 2021 (Figure 1.10). Severe restrictions on movement, business and social life lasted from about mid-March until June 2020. In late 2020, new restrictions emerged in response to a resurgence of infections across most of the region, however, higher public spending and less drastic lockdown restrictions attenuated this wave (World Bank, n.d.[32]) (Figure 1.11).
Source: Authors' calculation based on Our World in Data (2021[33]), Our World in Data website, https://ourworldindata.org/.
Source: Authors' calculation based on Our World in Data (2021[33]), Our World in Data website, https://ourworldindata.org/.
Source: Oxford University (2021[34]), Oxford COVID-19 Government Response Tracker, https://covidtracker.bsg.ox.ac.uk/.
Testing and vaccine capacity vary significantly among the economies in the region. Enhancing the timely detection of new potential cases and hotspots is critical. Montenegro conducted the largest number of tests compared to the rest of the region (644 254 tests per million inhabitants by the latest available data), and was closely followed by Serbia (Figure 1.12). With 28 people fully vaccinated per hundred inhabitants by the latest available data, vaccine capacity in Serbia is by far the highest in the region and also outpaces both the OECD and EU averages (Figure 1.13).
Source: Worldometer (2020[35]), “Coronavirus”, www.worldometers.info/coronavirus/.
Note: Last reported numbers are from May 2021.
Source: Worldometer (2020[35]), “Coronavirus”, www.worldometers.info/coronavirus/.
Overall, the region has weathered the pandemic’s economic impact better than expected, but some economies have been hit severely. Across the region, real GDP declined by 3.4% in 2020, compared to 6.1% for the EU. However, this average masks significant heterogeneity across the region, due to differences in economic structures and the extent of governments’ fiscal responses. Montenegro, heavily dependent on tourism experienced a deep contraction, while Serbia managed to contain the contraction relatively well (Table 1.3).
Governments contributed to this performance with a series of measures to mitigate the negative impact of the crisis on the economy. The various support measures included loan guarantees and tax deferrals for enterprises, cash transfer to citizen, waiwers of wage and social security contributions, price controls and various other measures to support different sectors. In addition, financial assistance came from international donors, including the World Bank and the European Union. Overall, the fiscal stimulus in the region ranged from 2.8% of GDP in Kosovo to 12.7% of GDP in Serbia, which helps explain Serbia’s GDP performance.
The pandemic has highlighted the need for effective health and social support services. Before the crisis, the regional economies spent on average 6.8% of GDP on health care, which is lower than the EU and OECD averages – 9.9% and 12.6%, respectively. While, Bosnia and Herzegovina and Serbia spent about 9.2% and 9.1% of GDP on health care, respectively, and have a relatively well equipped health sector in terms of infrastructure, Kosovo spent only 1.6% of GDP, indicating needs for substantial investments in infrastructure and equipment. Relatively high unemployment and widespread informality may also slow down recovery. Moreover, they imply that a significant share of the population risked remaining without adequate health and social assistance.
Women are particularly exposed to the collateral effects of COVID-19. As in other economies, loss of employment and lockdown conditions have raised concerns about increased exposure to the risk of domestic violence during the first wave of the COVID-19 crisis (Bami, 2020[36]; OECD, 2020[37]). Even before the crisis, domestic abuse existed and needed better enforcement of existing legislation, including upping the provision of shelters and issuing emergency protection orders more promptly. Women are affected in other ways too. They make up the majority of the healthcare workforce, which has exposed them to greater risk of infection. At the same time, women shouldered much of the burden at home, given school closures and longstanding gender inequalities in unpaid work.
Combining the visions, trends and multi-dimensional assessments of development, presented in this report, a number of priorities emerge that future strategies must address. This section presents the strategic opportunities and challenges that emerged as shared across the economies of the region. This regional overview and the initial assessments of each Western Balkan economy build the diagnostic basis for the next phases of the MDR of the Western Balkans, which will focus on peer learning to find solutions and ideas for action.
Particularly amid a COVID-19 pandemic, with its huge social and economic implications, learning from and with each other in order to tackle challenges and find innovative and timely solutions is more necessary than ever. The COVID-19 situation continues to change everywhere, and responses must be developed in real time. Simultaneously, the need for recovery spending makes strategic questions more urgent. Because a large amount of resources will be used, missed opportunities will be much more costly than they would be otherwise. Against this backdrop, the following shared strategic opportunities and challenges are presented with the hope that the ensuing peer-learning phase can help deliver solutions and play its part in making recovery spending as strategically effective as possible.
First, education and competences for economic transformation are the top priorities for all economies in the region. While economic structures vary significantly, finding new sources of productivity growth and engines for future transformation is an urgent task for all. Good jobs are scarce, and young people continue to leave. Boosting youth and workforce competences can unlock new opportunities to overcome these trends. This task is the more urgent, the more unfavourable an economy’s current wage-to-productivity ratio is. Kosovo tops this table, but the challenges are similar for all economies, and the differences in wage-to-productivity ratios are small.
Strategies for competences and top-notch education will both be needed. Strategies for competences and the future transformation of the economy must combine education with practical training, investment promotion and proactive creation of partnerships with firms, academia and more. Digitalisation, which is currently receiving a boost from the COVID-19 crisis, must be a key element of any competence strategy. Diasporas should be included as core assets in such strategies. Creating top education systems must be the second pillar. Pedagogical and curricular reform are needed, but the most important challenge will be moving from overstaffing to a focus on equity and performance. The region has a comparatively young population and must invest in it, from ECE through tertiary education. Economies learning from each other and from international experiences hold significant potential.
Second, social cohesion presents both an opportunity and a significant challenge for all societies in the region. Underperforming labour markets leave many without attractive opportunities and strain citizens’ ability to support each other. At the same time, the lack of formal labour market participation renders the mostly contribution-based social protection systems unsustainable and under-dimensioned. Large inequalities between sub-regions and between ethnic groups add to the complexity. Local governments should be on the frontlines in addressing this challenge but, in most places, lack the capabilities in terms of organisation, incentives and funding.
Strengthening social cohesion and resilience will require social protection reform, effective service delivery and supportive labour market institutions. The pandemic has underlined the importance of effective social protection systems in rendering societies resilient and in acting as automatic stabilisers in times of crisis. Even in normal times, social safety nets are important in creating trust and supporting citizens to participate fully in society. Systems vary across the region, but financial sustainability, lack of social assistance beyond pensions, and expensive regimes for particular groups are common challenges. The size of the informal economy makes it necessary to devise schemes that are universal and not based solely on contributions. Experiences around the world can serve as inputs for solutions. Effective service delivery, particularly at the local level, must be a key element of any social cohesion strategy. Examples of and ideas for stronger local governments that have the resources and capacities to deliver are necessary to overcome the sometimes egregious differences between localities. Labour market institutions must play a role in creating social cohesion. While much of the region’s employment performance owes to weak engines of economic growth, labour market institutions, such as matching mechanisms and the employment incentives supplied by labour legislation and social contributions, could play a much more effective role.
Third, energy and air pollution are complex challenges and significant obstacles to future economic development and well-being. Coal accounts for large to huge shares of energy supply across Western Balkan economies, except for Albania, which relies almost exclusively on hydropower. Many coal power plants are old and need decommissioning or significant investments to ensure reliable electricity supply. At the same time, coal, particularly when burned with old technology, is a driver of climate change and causes significant air pollution, which is the region’s foremost environmental burden. Given the current product space of most of the region, attainable opportunities could exist in energy-intensive metals and machines. However, this would only be possible with a more sustainable and reliable energy supply. Meanwhile, a cleaner environment, especially in the major urban centres, is a top desire of residents and would be crucial to making the region an attractive place to live, invest and return to.
Solutions to the energy-air pollution nexus will require a regional perspective. Already today, trade in electricity, especially between Albania and its neighbours, is frequent and helps partners achieve a better energy mix. Given the small size of each economy and the variation in their endowments in terms of natural resources and energy opportunities, a resilient, climate-friendly and high-performing energy mix only seems attainable at the regional level. While solar and wind energy can be exploited at small scale, hydropower and conventional energy production can play their role more productively at regional scale. As the energy transition beckons and huge investments must be made, it would now be a good time to engage in peer learning and mutual exchange about opportunities and ways forward, including on the basis of what has been done in other parts of the world. The same holds true for air pollution, which all regional economies must urgently address and for which innovation and inspiration are needed.
Fourth, digitalisation is an unstoppable global trend that can offer the region important opportunities for transforming education, the economy and governments. The COVID-19 pandemic, with its global shift to teleworking and digitalised services, has accelerated digitalisation. At a time when resilience requires the ability to keep an economy going while imposing physical distance between people, digitalisation is essential. Beyond the pandemic, digitalisation has the potential to become a building block of more competitive and productive economies in the region. Given the strong tradition of engineering and mathematics education and young populations eager to connect to the world, a push for digital competences has potential. Done right, bolstering digital skills could also help alleviate unfavourable wage-to-productivity ratios. The biggest potential of digitalisation might be in transforming governments and public service delivery. Inefficient government structures and lack of capacity for service delivery, especially at the local level, have been identified as major constraints to development in all initial assessments. Better governance and services were also among the top dimensions in all future visions. Examples of early-adopting economies, like Estonia, show that digitalisation can help re-engineer structures of the public administration for higher performance at lower cost.
Fifth, migration and brain drain present considerable challenges for all societies in the region; making more of diasporas, on the other hand, holds opportunity. Emigration and remittances have been defining features in most of the region over the last decade. They help take the pressure off underperforming labour markets and supply many households with additional income, significantly contributing to poverty reduction and improvements in living standards. They also deprive the region of young talents, potentially contributing to the lack of economic innovation and transformation. Public services, especially medical care, also suffer as qualified people leave. The emotional cost to those who remain is considerable and might fuel resentment towards the European project in the long run (Krastev and Holmes, 2019[38]). Yet, past migration holds significant potential in the form of a large diaspora in the more advanced economies of Europe and North America. Elsewhere in the world, diasporas have been important sources of investment and know-how, suggesting that more can be made of these links through investment programmes, sponsorships and incentives for return migration.
Sixth, women face particular obstacles to full participation in societies in the region. Across economies, women’s low participation in paid work due to full-time household chores, lack of child and elderly care services and cultural norms that encourage traditional division of labour is striking. This is in contrast to many post-communist societies, which traditionally have comparatively high levels of female labour market participation. While the current poor labour market conditions and high unemployment pose challenges for both men and women, and increased female participation could not easily be absorbed, things can change. If economies seize the opportunities laid out in this report and the initial assessments, demand for qualified labour, including female labour, will increase dramatically. Learning from each other about creating opportunities for women and about finding a good balance of opportunity in society can help generate solutions.
Seventh, land management and registration of property rights pose significant challenges in most economies, with deleterious consequences for rural development, revenue generation and the environment. The multiple changes in legal and political regimes in the last century have left most economies with significant numbers of overlapping land claims. These stem from both formal regime change and the fact that traditional – informal, from today’s perspective – means of land transfer have been used where formal channels were not sufficiently present or accessible. In addition to registration problems, cadastres are not complete everywhere and are at times incoherently organised. As a result, often property cannot be used as collateral to access financing, and much of farming is hampered by small plots, as growth through purchase of land is blocked. Yet, sustainable agricultural techniques often require larger plot sizes to generate sufficient returns, and the current small-plot structure incentivises intensive practices with heavy environmental tolls in the form of overuse of water and pesticides. Relevant experiences in land management abound internationally; peer learning could help create solutions for Western Balkan economies.
Eighth, a focus on local governments, their implementation capacities, funding and incentives can help identify important opportunities for future development. Local governments are key in implementation and delivery but often do not play their role. Local governments provide many services, such as education, health care, social assistance and water and waste services. Many municipalities have sizeable staff and spend the large majority of their budgets on salaries. However, benchmarking shows that the services delivered are not in line with what is spent on their delivery. Political patronage often plays an outsized role in hiring at the local level, and in some economies, the incentive structure, set by how local governments receive their funding from the centre, leads to further surplus hiring, as opposed to smart investments in performance. While the structure of multi-level government organisation varies, all economies struggle in some way with delivery at the local level. Learning from each other and from what has been done elsewhere in the world could point the way to new opportunities and solutions.
In the end, progress comes down to implementation and reliability. The high pace of production and the quality of legal texts and strategies across the region is impressive. Yet translation into practice oftentimes remains slow. State structures tend to be overly complex. Numerous ministries and agencies and unclear lines of accountability delay decisions and cost time and resources. Frequent political changes and insufficient protection against undue influence are other sources of delay and impediments. At the same time citizens place the rule of law, good governance and effective policy making very high in their visions of a good future. Coming together around the objectives of effective public delivery and implementation in a context of good governance can lead to paths towards new opportunities for development and enable achievements across the strategic priorities listed here.
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Note
← 1. Due to the outbreak of COVID-19 and the related travel restrictions, the OECD visioning workshop in Bosnia and Herzegovina was cancelled. This report therefore does not contain inputs for the economy’s vision.