Western Balkans: Stalled on Europe’s Edge

The economies of the Western Balkan countries — Albania, Bosnia & Herzegovina, Republic of Macedonia, Montenegro, Kosovo and Serbia — still lag behind the rest of Europe.

The regional average income levels fluctuate from an annual level of $5,300, to as low as only 31% of the EU-28 average.

In addition, the Western Balkans rank at the very bottom of the Catch-Up Index of the European Policies Initiative. This is an indicator that measures the performance of 35 European countries across four categories: economy, quality of life, democracy and governance. Bosnia & Herzegovina and Albania are ranked in the last positions.

The Balkan countries have fallen into the “middle income trap.” The industries that drove growth in the early period have become non-competitive, as rising wages have encouraged labor-intensive sectors to move to countries with lower wage rates.

Unfortunately, the era of rapid catch-up seems to have ended. Little growth spurts, followed by stagnation, lower the average growth and prolong the process of catching up with the more advanced economies.

Slower times

The International Monetary Fund outlook for economic growth in the region is grim. The regional growth rates are forecast at only 2-3% of change in the years to come. If this forecast proves to be true, the idea of any convergence with the EU countries will be hard to sustain.

Economists use the Rule of 72 to approximate how long it will take for a country to increase its income. This theory posits that income and output double at a 7% growth rate every decade.

As per this rule, it would take 25-36 years for the Western Balkans (at its current pace) to double its income – and 50 years to catch up with the EU average.

Ominously, the average rate of unemployment (24%) in the Western Balkans is the highest in Europe and twice the EU average. There is a comparatively low participation rate and lack of opportunities for young workers.

One of the biggest failures of the regional transition process was that the market economy was undermined by the informal economy and widening social disparities.

The recent euro-zone economic crisis further worsened the situation across the Western Balkans. Besides a weak external environment, it is the incomplete reform process that is holding it back from matching income levels of richer EU economies.

Economic indicators show a poor performance in creating competitive markets and improving the enterprise sector, which is underscored by very low productivity levels. Competitiveness remains highly unsatisfactory, with all countries ranking poorly in the World Economic Forum’s Global Competitiveness Report 2015.

The two main factors that contribute to the low competitiveness in the region are an unfriendly business environment – characterized by weak institutions and rule of law – and the limited role of innovation in the economy.

A costly unraveling

Equally important is the issue of rampant corruption. The European Commission identified organized crime and corruption as some of the major obstacles on the path to EU integration.

This is especially troublesome because these forces take a significant toll on regional prosperity. According to Global Financial Integrity, the dirty money from crime, corruption and tax evasion cost the Balkans an astounding $111.6 billion during 2001-2010.

Poverty and inequality trigger other security challenges in the Western Balkans. These include illegal migration toward EU countries, violent extremism, social unrest and regional insecurity.

All these factors represent threats to the security of Europe as a whole.

These problems have in turn created a negative image of the region among foreign investors. They are reluctant to invest in the Western Balkans, fearing various political and economic concerns.

Unfortunately, the entire region attracts less than 0.9% of the global foreign direct investment.

Biting the bullet

A sustainable reform agenda is required to prosper in a knowledge-based global economy. Most of the low-hanging fruits of the free-market economy have been reached. What remains now are the upper branches, which is difficult to reach.

The Balkan countries are at least a decade late in launching sustainable reforms. Now that the countries are running out of money, leaders will have to bite the bullet and institute serious reforms.

Economic growth is the key to an improved standard of living. Growth can never come by itself and, therefore, it is the responsibility of the governments to make the necessary reforms.

Structural changes have to be facilitated. This includes creating corruption-free business environments, investing in human capital through education and letting the market forces and investment incentives work.

On the other side, regional economic integration is imperative. The starting point towards better cooperation would be to acknowledge the fact that the Balkan countries are too small and weak individually to generate the sufficient scale and capacity, that will attract foreign investment and strengthen competitiveness.

Increasing regional trade and investment cooperation would help to collectively achieve more on the international stage and bring a multitude of positive effects for each country – and all of Europe.

The headline-grabbing security challenges in the Western Balkans is ultimately all about the local economies.