The Western Balkans in transition:

diagnosing the constraints on the

path to a sustainable market economy
By Peter Sanfey and Jakov Milatovic

February 2018
 The Western Balkans in transition: diagnosing the
constraints on the path to a sustainable market
economy1

Background paper for the Western Balkans Investment Summit, hosted by the EBRD,
26 February 2018
The views expressed in this paper are the authors’ only and not those of the EBRD

Abstract
The six Western Balkans countries have strong economic potential but face a major
convergence challenge in relation to comparator countries in the European Union.
Encouraging progress has been made in the past two decades in terms of regional cooperation
and advances towards eventual EU membership, and these trends are likely to continue,
boosting growth and investment. However, significant convergence towards EU living
standards requires a major and sustained boost to productivity and investment. Firm-level
productivity is significantly below EU standards, reflecting years of under-investment, weak
institutions and a difficult business environment. An econometric analysis of the constraints
to productivity and growth highlights the problems of corporate over-indebtedness and
market concentration. A survey of firm owners and senior managers reveals the difficulties
caused by the activities of competitors in the informal sector. Small businesses in particular
find this obstacle, as well as corruption, highly problematic. Other constraints cited
frequently include the cumbersome tax administration, difficulties in accessing a reliable
electricity supply, and limited access to finance. Using the EBRD’s new framework of six
transition qualities for assessing progress towards sustainable market economies, the paper
shows that the Western Balkans region scores poorly relative to EU peers in terms of all six
qualities, and particularly in the areas of competitiveness and good-governance. These results
highlight the need for the implementation of a comprehensive and wide-ranging reform
programme.

1
This paper was prepared by Peter Sanfey and Jakov Milatovic from the Department of Economics, Policy and
Governance (EPG) at the EBRD. Important contributions to the analysis were made by Peter Tabak, Oleg
Levitin, Sanja Borkovic, Ana Kresic and (ex-EBRD colleague) Emir Zildzovic. We are also grateful to
numerous other colleagues in EPG for helpful comments and suggestions, and in particular to Isabel Blanco and
Damin Chung for background analysis on green issues, and Alper Dincer for contributions to the section on
inclusion. This draft has also benefited from comments from EBRD colleagues in other departments, including
Banking, Environment and Sustainability, and the Office of the General Counsel. The views expressed in this
paper are those of the authors only and not necessarily those of the EBRD.

1
Executive summary
The six Western Balkans countries face a major convergence challenge in relation to
comparator countries in the European Union (EU). It will take decades, even amid optimistic
scenarios, for the region to catch up to average standards of living in the EU. Full
convergence will require a major and sustained boost to productivity and investment, but the
conditions for such a boost are not yet in place.
Encouraging progress has been made in the past two decades in terms of regional cooperation
and advances towards eventual EU membership. The new format of regional cooperation
initiated by the EBRD in February 2014 has contributed to the strengthening of regional
stability and improved coordination and prioritisation of regional connectivity projects.
Important steps are now being made to enhance regional “soft connectivity” through the
development of a single investment space. The prospect of eventual EU accession remains a
key anchor for reforms, but the ability to assume the obligations of EU membership varies
significantly across the region.
The fundamental problem holding back the region’s economic development is low
productivity. This reflects years of under-investment, weak institutions and a difficult
business environment. The private sector is the main contributor to economic output in all
countries; nevertheless, the state retains a dominant role in key industries in several countries
of the region, and a significant privatisation agenda lies ahead. Small and medium-sized
enterprises (SMEs) dominate the private sector and account for about two-thirds of value
added on average.
An econometric analysis of the constraints to productivity and growth highlights the
importance of a number of factors and qualities. Corporate over-indebtedness and market
concentration are two variables that help explain poor productivity performance, as does the
low level of youth inclusion. Complementary evidence comes from a major survey of firm
owners and senior managers, which reveals the difficulties caused by the activities of
competitors in the informal sector. Small businesses in particular find this obstacle, as well as
corruption, highly problematic. Other constraints cited frequently by interviewees include the
cumbersome tax administration, difficulties in accessing a reliable electricity supply, and
limited access to finance.
In light of the above evidence, it is clear that countries in the Western Balkans fall short of
being considered well-functioning, sustainable market economies. But how large are the
remaining gaps? This question is addressed using the EBRD’s new framework of six
transition qualities. Looking at the EBRD’s assessment, this region scores well below EU
peers in terms of all six qualities: competitive, well-governed, green, inclusive, resilient and
integrated. Many of the obstacles to private sector development outlined in the paper
contribute to the low scores, highlighting the need for implementation of a comprehensive
and sustained reform programme over the coming years.

2
1. Introduction
The Western Balkans is a region of unfulfilled potential. The Western Balkans –
comprising six countries: Albania, Bosnia and Herzegovina, FYR Macedonia, Kosovo,
Montenegro and Serbia, with a total population of about 20 million and a combined GDP of
roughly €80 billion – lies at the heart of Europe and is surrounded by European Union (EU)
countries. But weak economic performance, combined with political instability and upheaval
over recent decades, has left the region lagging behind EU comparators in terms of prosperity
and living standards. GDP per capita in the Western Balkans is on average just one-quarter of
the level in the richest EU members in western Europe.
Narrowing the gap in living standards will require an intensification of reforms needed
for building sustainable market economies. Weak institutions and the absence of
appropriate incentives for high levels of long-term productivity are at the heart of this
prosperity gap. Countries in the region are a long way from embracing a sustainable market
economy, defined as one that is competitive, well-governed, green, inclusive, resilient and
integrated. Comprehensive reforms are needed to promote a dynamic, vibrant private sector,
backed by strong investment flows, both domestic and foreign. The state must play an
important growth-enabling role by providing the rule of law, a stable macroeconomic
environment and clear rules of the game for businesses.
Achieving sustainable market economies in the Western Balkans will depend on a
number of fundamental obstacles being overcome. This paper shows that several problems
are common across the region. The main obstacles that businesses face in their day-to-day
operations include weak rule of law, unfair competition from the informal sector, corruption
and cumbersome tax administration, difficulties in getting reliable electricity supply, and
limited access to finance.
The paper proceeds as follows. In section 2 we discuss the convergence potential of the
region. Sections 3 and 4 elaborate on regional cooperation and EU approximation of the
Western Balkans, two major external processes driving the region’s economic development.
Section 5 outlines the broad economic structure of the countries. Section 6 summarises the
role of the private sector in economic activities, while section 7 expands on the obstacles and
challenges to private sector development. Lastly, section 8 assesses the state of each of the
six qualities of a sustainable market economy.2

2
Our paper draws heavily on three working papers: “How the Western Balkans can catch up” by Peter Sanfey,
Jakov Milatovic and Ana Kresic (EBRD Working Paper No. 185), “Firm performance and obstacles to doing
business in the Western Balkans: evidence from the BEEPS” by Ana Kresic, Jakov Milatovic and Peter Sanfey
(EBRD Working Paper No. 200), and “Productivity drivers in the Western Balkans” by Sanja Borkovic, Peter
Tabak and Emir Zildzovic (EBRD Working Paper – forthcoming). Other relevant papers and contributions are
cited in footnotes throughout the text.

3
2. Convergence potential
Countries in the Western Balkans (WB-6) face a major convergence challenge. Current
average GDP per capita for the six countries is only half the average in the 11 EU member
states of eastern Europe (EU-11), and just one-quarter of the most advanced western
European countries (Chart 1).3 As discussed in more depth below, the main reason behind
this prosperity gap is the lack of appropriate factors and institutions needed for high levels of
long-term productivity growth.4

Chart 1: GDP per capita (PPP adjusted)

Source: IMF World Economic Outlook.

Note: Countries are ordered within sub-regions from highest to lowest. Luxembourg is an outlier in
terms of GDP PPP per capita and is not included.

Some catch-up with EU living standards has taken place in the past 15 years. The
(weighted) average annual growth rate of the Western Balkans region between 2001 and
2016 was 3.2 per cent, compared with 1.4 per cent in the EU. However, this period can be
divided into two distinct phases: the pre-crisis period (2001-08) and the post-crisis period
(2009-16). During the former, annual growth (weighted average) in the WB-6 was more than
three percentage points higher than in the EU (5.3 versus 2.2 per cent). In the latter period,
there were double dip recessions in 2009 and 2012 and average WB-6 growth in this period
was just 1.2 per cent, compared with 0.7 per cent in the EU. The speed of convergence has
thus slowed down markedly over the past seven years.

3
The EU-11 refers to the 11 former socialist countries from central Europe, the Baltic states and south-eastern
Europe that joined the EU in 2004 or since then, namely: Bulgaria, Croatia, the Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic and Slovenia.
4
For further analysis see “How the Western Balkans can catch up” by Peter Sanfey, Jakov Milatovic and Ana
Kresic, (EBRD Working Paper No. 185).

4
Full convergence with average EU living standards could take many decades. A baseline
scenario, which uses the average growth rates for the period of 2001-16, implies that the WB-
6 region, on average, could achieve the average GDP per capita in the EU in about 60 years
time. An optimistic scenario, which uses pre-crisis growth rates, would yield catch up with
EU living standards in just under 40 years, while a pessimistic scenario, which uses the post-
crisis average growth rates, means that catching up takes place after 200 years (Chart 2). The
speed of catch up would depend on the pace of addressing the challenges that hamper the
region from developing its full potential.

Chart 2: Convergence scenarios

160,000 pessimistic
scenario
140,000 2220
baseline
Current international Dollar

120,000 scenario
2078
100,000 optimistic
scenario
80,000 2053

60,000

40,000 GDP EU
per capita WB
20,000

0
2016 2220

Source: IMF World Economic Outlook; authors’ calculations, based on assumptions outlined in the
text.

Convergence on inflation has largely occurred. All Western Balkans economies are
currently enjoying a high degree of price stability, with inflation rates similar to those of
advanced EU countries. Low inflation in the eurozone and the fall in global commodity
prices have been important contributors, but stable exchange rate regimes are also key pillars
of this stability. A floating exchange rate is present in Albania and Serbia but excessive
fluctuations are kept in check by central bank interventions. In the remaining Western
Balkans countries the exchange rate is immovable in relation to the euro, either because the
euro is the only legal tender due to unilateral adoption (Kosovo and Montenegro) or because
the rate is fixed through a currency board (Bosnia and Herzegovina) or a long-standing peg
(FYR Macedonia).

5
3. Regional cooperation
Economic activity has been enhanced by growing regional cooperation. The increase in
regional cooperation in the past decade, following the conflicts in the 1990s, has been one of
the greatest recent achievements of the Western Balkans, and has brought with it two key
benefits. First, it reduces tension and strengthens regional stability, allowing more attention to
focus on common economic challenges and increasing the attractiveness of the region as an
investment destination. And second, it brings various practical benefits that stem from higher
levels of intra-regional flows of people, goods, services and capital, thus enhancing the
competitiveness of relatively small economies.
A new format for high-level regional cooperation has been established. On 24 February
2014, the EBRD hosted at its Headquarters in London a Western Balkans Summit, which
brought together, for the first time in such a format, the prime ministers of all six countries of
the region, de facto launching a new format of regional cooperation: “Western Balkans Six at
the level of Prime Ministers”. Besides promoting the Western Balkans as an investment
destination, the summit contributed to the strengthening of regional stability and improving
regional cooperation. In particular, it strongly promoted the need for better prioritisation and
coordination of major regional connectivity projects among the beneficiaries, as well as
between the European Commission (EC), international financial institutions (IFIs) and
bilateral donors, and the importance of inclusive partnership and the need to bring the EBRD
and other IFIs on board at the earliest stage in the consideration and design of major regional
projects.
Extension of the Trans-European Network to the region was one of the major results of
this regional cooperation and coordination. The efforts to advance a few major priority
connectivity projects in transport and energy culminated in an agreement, reached at the high-
level meeting between the EC and Western Balkans prime ministers in Brussels in April
2015, on the regional core transport and energy network for the Western Balkans as an
extension to the region of the Trans-European Network (TEN-T). This ensures closer
integration of the region with the EU and is the basis for leveraging investment in
infrastructure. The EC announced an allocation of €1 billion over seven years for funding
these priority projects. As part of the efforts to improve coordination in developing regional
projects, all Western Balkans countries established National Investment Committees (usually
headed by the prime ministers) and national coordinators, tasked with preparing Single
National Project Pipelines for priority investments, as a precondition for EU grants funding
for transport investment.
Soft connectivity is increasingly in focus. The Western Balkans Six process received the
strongest political boost at the August 2014 Summit in Berlin, which paved the way for the
Berlin Process.5 The biennial Western Balkans Summits at the EBRD are complementary to
the annual summits of the Berlin Process, while maintaining their initial strong focus on
investment promotion. The third Western Balkans Summit at the EBRD, scheduled for 26
February 2018, will continue the work on investment promotion and on promoting concrete
regional projects in transport and energy to unlock key regional bottlenecks. But there is
more to regional integration than physical infrastructure alone. The additional new theme of
this EBRD summit is the “soft connectivity” agenda. A key element of the latter is the

5
The Berlin Process is a series of annual meetings of the six Western Balkans prime ministers and six EU states
with a particular interest in the region, hosted by different EU countries, launched in August 2014 in Berlin, and
serving to discuss important regional topics related to future EU membership of the region. The 2014 summit in
Berlin was followed by Vienna in 2015, Paris in 2016 and Trieste in July 2017; the next, in July 2018, will be
held in London.

6
creation of a single investment space, which includes harmonising legislation, removing non-
tariff barriers, improving both the depth and horizontal links of capital markets, strengthening
the business environment in the region, and facilitating foreign investment. This is a
contribution to developing the EU-supported Regional Economic Area (see below).
An action plan for an EU-compliant regional economic area in the WB-6 is in place. One
of the outcomes of the Western Balkans Summit in July 2017 in Trieste was the adoption of a
“consolidated multi-annual action plan for a regional economic area in the Western Balkans
six.” The intention is to move the six countries beyond the existing free trade agreement and
towards a more comprehensive economic cooperation. There are four components of the
Regional Economic Area to be addressed by the action plan: (i) trade, (ii) investment, (iii)
mobility and (iv) digital integration. All six countries have committed to deepening their
collaboration within the current regional free-trade agreement (CEFTA) to the point where
goods, services, investments and skilled people can move freely within the region without
tariffs, quotas or other unnecessary non-tariff, and other, barriers.
Bilateral relations in the region have also advanced. The strengthened coordination
between the WB-6 and the key international stakeholders has been accompanied by progress
in the reconciliation and strengthening of good neighbourly relations in the region. Highlights
include, among others, the EU-facilitated dialogue between Belgrade and Pristina aimed at
the normalisation of the relations between the two, and the rapprochement between Serbia
and Albania.

7
4. EU approximation
The prospect of EU membership is a key driver of reforms. Accession negotiations have
been opened with two candidate countries: Montenegro (2012) and Serbia (2014). By the end
of 2017 Montenegro had opened 30 out of 33 negotiating chapters, with three provisionally
closed, while Serbia had opened 12 out of 34 negotiating chapters and provisionally closed
two. FYR Macedonia has been a candidate country since 2005, but accession negotiations
have not been opened yet as the country’s name dispute with Greece remains unresolved.
Albania became a candidate country in 2014, and is waiting for the opening of accession
negotiations. In November 2016 the EC recommended the conditional opening of EU
accession negotiations with Albania, following the adoption of an important judicial reform
package in July 2016, but the recommendation remains conditional on (among other things)
tangible progress in implementation of these reforms. Bosnia and Herzegovina applied for
membership in 2016, following the entry into force of the country’s Stabilisation and
Association Agreement (SAA) in June 2015, and Kosovo has a Stabilisation and Association
Agreement, which entered into force in April 2016.
Progress on fulfilling the Copenhagen accession criteria is being assessed according to a
new methodology. The Copenhagen criteria are divided into three areas, including (i)
political criteria: stability of institutions guaranteeing democracy, the rule of law, human
rights and respect for and protection of minorities; (ii) economic criteria: a functioning
market economy and the capacity to cope with competition and market forces; and (iii)
institutional capacity to effectively implement the EU acquis. The 2015 EC Enlargement
Strategy introduced a new methodology to quantify the progress of aspirant countries in the
abovementioned aspects. Charts 3 and 4 show the scores from the latest EC Progress Reports
in the areas of the rule of law (functioning of the judiciary, fight against corruption and fight
against organised crime) and economic reforms (the existence of a functioning market
economy and the capacity to cope with competition and market forces within the EU). The
scores are on a five-point scale: (1) at an early stage, (2) some level of preparation, (3)
moderately prepared, (4) good level of preparation, and (5) well advanced.

Chart 3: State of progress in the area of Chart 4 : State of progress in economic

the rule of law reforms
5 5

4 4

3 3

2 2

1 1
ALB BIH MKD KOS MNE SRB ALB BIH MKD KOS MNE SRB
Functioning of the judiciary The existence of a functioning market economy
Fight against corruption The capacity to cope with competitive pressure within the EU
Fight against organised crime Public administration reform

Source: European Commission, Progress Source: European Commission, Progress

Reports. Reports.

8
Western Balkans countries are more advanced in economic reforms than in the rule of
law. Based on this new assessment methodology, most countries have only “some level of
preparation” in the three areas of the rule of law, including functioning of the judiciary, fight
against corruption and fight against organised crime. This is a long way from the “well
advanced” state of progress needed for EU accession. The situation is a bit better with regard
to economic reforms, where most countries are “moderately prepared”. Bosnia and
Herzegovina and Kosovo are lagging behind, being assessed at “an early stage” in this area.
The ability to assume the obligations of EU membership varies significantly across
countries and criteria. Table 1 summarises the countries’ ability to assume the obligations
of EU membership in different negotiating chapters, assessed in the latest EC progress
reports. The areas where the region as a whole has the lowest scores include: (i) financial and
budgetary provisions, (ii) freedom of movement of workers, (iii) food safety, veterinary and
phytosanitary policy, (iv) agriculture and rural development, (v) environment and climate
change, (vi) consumer and health protection, (vii) social policy and employment and (viii)
judiciary and fundamental rights. Some areas have relatively good overall scores, including:
(i) foreign, security and defence policy, (ii) external relations, and (iii) customs union. On
average, the ability of the region to assume the obligations of the EU membership is between
“some level of preparation” and “moderately prepared”.

9
Table 1: Countries’ ability to assume obligations of EU membership
WB-
6
BIH KOS ALB MKD SRB MNE avg
1 Free movements of goods 1 2 3 3 3 3 2.5
2 Freedom of movement for workers 1 1 1 1 3 2 1.5
3 Freedom to provide services 1 1 3 3 3 3 2.3
4 Free movement of capital 3 2 3 3 3 3 2.8
5 Public procurement 2 2 2 3 3 3 2.5
6 Company law 1 1 3 4 4 4 2.8
7 Intellectual property law 3 2 2 3 4 4 3.0
8 Competition policy 2 1 3 3 3 3 2.5
9 Financial services 1 1 3 3 3 3 2.3
10 Information society and media 1 2 3 4 3 3 2.7
11 Agriculture and rural development 1 2 1 3 2 3 2.0
12 Food safety, etc 1 2 2 2 3 3 2.2
13 Fisheries 1 2 1 3 3 1 1.8
14 Transport policy 2 2 2 3 4 4 2.8
15 Energy 1 1 3 3 3 4 2.5
16 Taxation 3 3 3 3 3 3 3.0
17 Economic and monetary policy 1 1 3 3 3 3 2.3
18 Statistics 1 2 3 3 3 2 2.3
19 Social policy and employment 1 1 2 3 3 2 2.0
20 Enterprise and industrial policy 1 2 3 3 3 3 2.5
21 Trans-European networks 2 4 3 3 3.0
22 Regional policy, etc. 3 3 3 3 3.0
23 Judiciary and fundamental rights 2 1 2 2 2 3 2.0
24 Justice, freedom and security 2 2 2 3 2 3 2.3
25 Science and research 1 1 1 4 4 4 2.5
26 Education and culture 1 1 3 3 4 4 2.7
27 Environment and climate change 2 1 2 2 2 2 1.8
28 Consumer and health protection 1 1 1 3 3 3 2.0
29 Customs union 3 3 3 4 4 3 3.3
30 External relations 3 3 3 4 3.3
31 Foreign, security and defence policy 4 3 3 4 3.5
32 Financial control 1 1 3 3 3 3 2.3
33 Financial and budgetary provisions 2 1 1 1 1.3

Average 1.5 1.6 2.4 2.9 3.0 3.0 2.4

Source: European Commission.

Note: The scores in the table are based on the EC’s assessment of a country’s preparedness to adopt
the obligations of EU membership according to the following description: (1) early stage, (2) some
level of preparation, (3) moderately prepared, (4) good level of preparation, and (5) well advanced.

10
5. Economic structure
Economies in the Western Balkans region tend to be diverse, rather than relying on one
or a few sectors. Nevertheless, four sectors stand out as being of particular importance,
namely: domestic trade, industry, public administration and agriculture. Chart 5 shows the
contribution of different sectors in each country to gross value added (GVA).6 Domestic
trade, including transport and storage, accommodation and food services, is on average the
largest sector of the Western Balkans economies, ranging from 18 per cent of GVA in
Albania and Serbia to 27 per cent in Montenegro. While the wholesale and retail trade
subsector accounts for about 15 per cent of the economies in the region, the importance of the
accommodation and food services subsector in tourism-dependent Montenegro, with a share
of 8 per cent, is what distinguishes this country from the rest of the region.
Industry accounts for one-fifth of GVA on average. However, this varies significantly
across countries. The role of industry is particularly important in Serbia (where it represents
an equally important part of the economy as in the average EU-11 country) and, to a slightly
lesser extent, in Bosnia and Herzegovina and Kosovo. Manufacturing is the predominant
industrial subsector, especially in Serbia, FYR Macedonia and Kosovo. The utilities
subsector of industry, including energy production, is important for Bosnia and Herzegovina
and Montenegro. The mining subsector plays a minor role, ranging from 1 per cent of the
economy in Montenegro to 3 per cent in Kosovo.
Public administration is the third largest economic sector. The sector includes defence,
education, social services and other public administration, and accounts for 17 per cent of
economic activity on average. This ranges from only 13 per cent in Albania to over one-fifth
of the economy in Bosnia and Herzegovina. Such a high share of public administration in the
Bosnian economy reflects the multiple layers of the country’s government, including the
central government, governments of two entities and the Brčko district, cantonal governments
in the Federation of Bosnia and Herzegovina, as well as local administration across the
country.
In general, the region is quite agriculture-intensive. Agriculture (together with forestry
and fishing) accounts for 12 per cent of value added on average, ranging from 7 per cent in
Bosnia and Herzegovina to 23 per cent in Albania. Agriculture plays a vital role in the
Western Balkans, both socially and in terms of employment. This contrasts significantly with
the EU-11 where on average the sector accounts for only 4 per cent of GVA. Serbia stands
out as having a clear comparative advantage in farming, mainly due to fertile agricultural soil
in its northern province of Vojvodina. Some large producers have been able to take advantage
of both economies of scale and access to major export markets, primarily the European Union
but also Russia, with which Serbia has a free trade agreement (the only country in the region
in this position). The other five countries have less advanced agricultural sectors, mainly
consisting of small-scale and inefficient subsistence farming. The potential for agribusiness to
develop further in the region is significant provided countries can consolidate agricultural
holdings, improve the quality of collection, storage and marketing, and develop agricultural
support services such as insurance.

6
GVA is linked to gross domestic product (GDP) through the following relationship: GVA + taxes on products
- subsidies on products = GDP.

11
Chart 5: GDP breakdown by sectors

3 3 4 3 3 3
3 6 4 5 5 Others
5 5
4 4 4
3 7 3 6
4 5 4 Information & Communication
11 5 7
5 5
6 12
8 Professional, Sci. & Admin. Services
7 14 11
7
14 10 Financial & Insurance Activities
10 9
23 22 Construction
18 19 14
16 Real Estate Activities
13
14 Agriculture, Forestry & Fishing
21
20 18 25
14 Public Adm., Defense & Social Security

Industry
23 27
18 21 21 18
Trade, Transport & Food Services

Albania BIH Kosovo FYRoM Montenegro Serbia

Source: National statistical offices.

SMEs dominate the economies of the Western Balkans. According to a recent OECD-led
study, SMEs make up about 99 per cent of businesses in all countries of the Western
Balkans.7 On average, SMEs provide jobs for around three-quarters of the total number of
employed, ranging from just below 70 per cent in Bosnia and Herzegovina to more than 80
per cent in Albania (Chart 6). At the same time, on average, SMEs add an estimated two-
thirds of the countries’ total annual value added, a proportion similar to the EU average,
ranging from just above 50 per cent in Serbia to just below 70 per cent in Albania (Chart 7).
Chart 6: SMEs sector employment, share Chart 7: SMEs sector value added, share
of total of total
100.0 100.0

90.0 90.0
81.0
80.0 76.6 74.9 80.0
70.4
68.4 67.7
70.0 70.0 66.6
64.5
62.4
60.0 60.0
53.0
50.0 50.0
ALB MKD KOS SRB BIH ALB MKD MNE BIH SRB

Source: OECD. Source: OECD.

The EU is by far the region’s most important trading partner. Two-thirds of the region’s
exports are with the EU (Chart 8). The share ranges from 80 per cent in FYR Macedonia to
just 23 per cent in Kosovo. All countries have a Stabilisation and Association Agreement
7
SME Policy Index: Western Balkans and Turkey 2016, http://www.oecd.org/countries/albania/sme-policy-
index-western-balkans-and-turkey-2016-9789264254473-en.htm.

12
with the EU, which gives the countries preferential access to EU markets for most goods. On
average 20 per cent of Western Balkans exports go to neighbouring countries. This figure
covers a range from a 46 per cent share in Kosovo to a mere 9 per cent in Albania. Exports
from the WB-6 countries grew by about 60 per cent on average over the past 10 years, and
most of this growth was driven by the rise of exports to EU countries. One reason for this
might be in the similarity of the Western Balkan countries’ main export products, although
there are important differences among the six countries in terms of revealed comparative
advantage.8

Chart 8: Exports, by destination as per cent of total exports

100%
90% 5 5 5
12
80% 9 12 6
18
70% Others
60% RUS
40
50% TUR
46
40% 80 CHN
76 75
66 WB-6
30%
EU28
20% 37
10% 23

0%
MKD ALB BIH SRB MNE KOS

Source: UNCTAD and the Central Bank of Kosovo, authors’ calculations.

8
This issue is analysed further in: “Firm performance and obstacles to doing business in the Western Balkans:
evidence from the BEEPS” by Ana Kresic, Jakov Milatovic and Peter Sanfey (EBRD Working Paper No. 200).

13
6. Role of the private sector
A state presence is still pervasive in key industries in several countries. Although most
economic activity in the region is produced by the private sector, a major restructuring and
privatisation agenda remains in Bosnia and Herzegovina (especially the Federation entity),
Kosovo and Serbia, while important assets also remain to be restructured and/or sold in
Albania, FYR Macedonia and Montenegro. Many of these state owned enterprises (SOEs) are
loss-making, while those that report profits are often highly inefficient. Important loss-
makers in the region include: coal mines and the railways company in the Federation of
Bosnia and Herzegovina; Montenegro Airlines and companies in the railways sector in
Montenegro; and the railways company and several chemical companies in Serbia.
Privatisation could bring significant benefits, but must be designed carefully. The
experience of large-scale privatisation across the whole transition region over 25 years
suggests that political commitment, ownership and transparency of the process are critical for
the success of any privatisation programme.9 Also, the programme works much better if it is
part of a broader reform programme. At the same time it is important to put in place
mitigating measures so that the negative social implications of privatisation (including job
losses) are successfully overcome.
Productivity in the private sector lags well behind EU standards. The EBRD-World Bank
Business Environment and Enterprise Performance Survey (BEEPS), last carried out in 2013,
data allow one to calculate a rough measure of labour productivity, defined as total sales
divided by full-time employment, in the private sector. The data highlight the labour
productivity gap between Western Balkans countries and the EU-11. Chart 9 shows that, on
average, aggregated firm level labour productivity in WB-6 companies is about 60 per cent of
that of the EU-11. Chart 10 demonstrates that this gap is driven by the manufacturing sector;
the productivity of this sector in the WB-6 is around 55 per cent of that of the EU-11. In the
WB-6 region, manufacturing is most productive in Serbia and Bosnia and Herzegovina, with
both countries having a strong industrial basis. Services (wholesale, retail, transport,
accommodation and food services) are more productive than manufacturing in all WB-6
countries, except in Albania, but still on average only 70 per cent of EU-11 levels.
Chart 9: Labour productivity, overall Chart 10: Labour productivity by sectors

Source: EBRD BEEPS V, 2013.

Note: Average labour productivities for EU-11 and WB-6 are calculated as weighted averages of the median values for each
country, with GDP being the weight. Outlier analysis has been performed.

9
See S. Slavova (2016), “Insights into the privatisation of large state-owned enterprises”, policy paper prepared
for the Economics, Policy and Governance Department, in the Vice Presidency, Policy and Partnerships of the
EBRD.

14
7. Obstacles and challenges to private sector development
The private sector across the region is held back by numerous obstacles. Many previous
studies and cross-country indicators have shown the various ways in which Western Balkans
countries lag behind EU standards, whether in terms of overall competitiveness, weak
institutions, low standards of governance or barriers to trading across borders, to take some of
the most commonly cited problems. But which obstacles are the most severe, and are there
important differences across the six countries? The following analysis, based on background
research papers, attempts to answer these questions.10
Corporate productivity is adversely affected by a range of common obstacles in the
region. An econometric analysis of total factor productivity (TFP) at the firm level in three
countries – Bosnia and Herzegovina, FYR Macedonia and Serbia – demonstrates a
statistically significant impact of several variables on productivity (see Table 2).11 Most
notably, corporate over-indebtedness is associated with lower productivity, as is a high
degree of market concentration. The impact of these two factors seems to be higher in FYR
Macedonia than in Bosnia and Herzegovina or Serbia but is significant in all three countries.
Another important finding is that enhancing the quality of the business and macroeconomic
environment and improving the transport and telecommunications networks would be linked
with significantly increased productivity of firms in Serbia and Bosnia and Herzegovina.
Similarly, companies in both countries would benefit from higher youth inclusion, which is
an important topic at the regional level given the high youth unemployment rates in all
Western Balkans countries. Improving the quality of institutions in Serbia also implies a
boost to corporate productivity, while in FYR Macedonia it would be accompanied with a
decreasing public sector.

There are also several country-specific corporate productivity drivers. The same analysis
shows that these drivers range from improved access to finance in Bosnia and Herzegovina to
higher energy efficiency in Serbia. In Serbia, higher productivity at the firm level is also
associated with better corporate governance (as demonstrated by the finding that greater
delegation of authority within a firm tends to increase firms’ productivity), while in FYR
Macedonia productivity improvements could come from an increase in the quality of higher
education and training. Although there is a widespread perception that SOEs in the region are
generally less productive than private companies, the econometric results confirm it only in
the case of FYR Macedonia.

10
This sections draws mainly on two background research papers: “Firm performance and obstacles to doing
business in the Western Balkans: evidence from the BEEPS” by Ana Kresic, Jakov Milatovic and Peter Sanfey
(EBRD Working Paper No. 200), and “Productivity drivers in the Western Balkans” by Sanja Borkovic, Peter
Tabak and Emir Zildzovic (EBRD Working Paper – forthcoming).
11
See Borkovic et al. (forthcoming) who use firm-level data drawn from the BvD ORBIS database for the
period 2007-15. The data are matched with firm-, sector- and country-level data covering a range of potential
TFP determinants such as governance, infrastructure, access to finance and employment opportunities, among
many others. The methodology underlying this analysis can be summarised as follows: first, a standard
production function (assuming a Cobb-Douglas form) is estimated by regressing sales on labour, capital and
intermediate inputs (all in logs). Under certain assumptions, TFP can be calculated straightforwardly as a
residual, using the estimated coefficients on the three explanatory variables. Second, these TFP estimates can
then be used (in difference form) as the dependent variable in a second-stage regression, where the explanatory
variables now include a variety of firm-specific, macroeconomic, institutional and business environment
variables.

15
Table 2: Total factor productivity drivers by country
Well-
Resilient Competitive Inclusive Integrated Green
governed
Quality of
Doing Market Youth Quality of
macroeconomic
business concentration employment infrastructure
environment
Bosnia and
Herzegovina Access to
finance for
Leverage
excluded
groups

State owned Market

Overleverage
enterprises concentration
FYR
Macedonia Institutions Employees
and share of and quality of
public sector education
Quality of
Quality of Market Youth Quality of Energy
macroeconomic
institutions concentration employment infrastructure efficiency
environment
Horizontal and
Doing
Serbia forward NPL
business
spill-overs
Corporate
governance:
delegation
of authority
Standardised coefficients
* Darker shades indicate higher relative importance of the variables, that is, higher
standardised coefficient (showing the impact of one standard deviation change in ≥|0.3|
the variable on productivity).
|0.2-0.3|

|0.1-0.2|

≤|0.1|
Source: Borkovic, Tabak and Zildzovic (forthcoming).

Survey results also point to common problems across the region. The BEEPS includes
questions about the subjective perceptions of business owners and senior managers about
different potential problems, and as such it can be quite revealing about the actual situation
on the ground. The survey approaches the issue in two ways: one method is to show
respondents a card with 15 potential obstacles and ask them: Can you tell me which of the
elements of the business environment included in the list, if any, currently represents the
biggest obstacle faced by this establishment? Table 3 shows the results for the six Western
Balkans countries. The second approach is to ask interviewees through the survey to rate the
severity of each obstacle on a five-point scale, ranging from “no obstacle” up through
“minor”, “moderate”, and “major” to “very severe”. These results, showing the percentage
who say major or very severe, are in Table 4.

16
Table 3: Biggest obstacle to doing business, percentage vote by country
ALB BIH MKD KOS MNE SRB Average
Competition from informal sector 16.8 4.1 26.0 23.3 12.5 9.8 15.4
Political instability 4.8 30.2 8.8 3.6 4.8 26.7 13.2
Access to finance 12.9 14.9 18.6 14.6 6.3 9.0 12.7
Tax rates 9.8 7.9 7.6 5.0 26.4 15.0 11.9
Corruption 6.3 7.8 1.4 9.8 0.9 10.9 6.2
Electricity 13.6 1.5 5.7 7.0 1.8 0.2 5.0
Customs and trade regulations 1.0 7.6 1.8 8.4 6.3 3.1 4.7
Tax administration 11.6 1.2 2.4 3.9 1.8 4.9 4.3
Inadequately educated workforce 1.9 2.0 5.9 6.3 1.9 5.7 3.9
Courts 0.2 3.3 4.5 1.3 0.2 4.2 2.3
Access to land 5.9 0.8 1.1 1.8 0.9 0.9 1.9
Labour regulations 0.1 6.5 0.6 0.4 3.0 0.1 1.8
Crime, theft and disorder 1.5 1.9 1.0 2.2 1.8 1.2 1.6
Transport 2.7 2.8 1.0 0.9 0.7 0.4 1.4
Business licensing and permits 1.3 3.7 0.4 1.3 0.3 1.2 1.3
Don't know 6.5 2.0 0.5 1.8 15.9 4.1 5.1
Refused 0.0 1.4 9.9 8.0 9.1 1.1 4.9
Does not apply 3.3 0.5 3.0 0.5 5.6 1.7 2.4
Source: BEEPS V.
Note: All companies; no differentiation between the industries; individual observations weighted
(strata weights). The categories sum up to 100.

Table 4: Obstacles to doing business, by percentage who perceive a major or very severe
problem
ALB BIH MKD KOS MNE SRB Average
Competition from informal sector 19.9 16.0 34.6 58.9 11.2 12.6 25.5
Political instability 11.1 34.3 21.7 45.7 0.4 31.5 24.1
Corruption 17.0 26.4 13.3 51.0 3.2 24.5 22.6
Electricity 21.6 10.2 28.9 49.5 6.0 6.6 20.4
Tax rates 12.8 20.3 16.0 30.2 8.7 25.5 18.9
Access to finance 6.5 14.1 19.3 44.9 7.6 15.7 18.0
Tax administration 13.1 13.1 10.3 28.2 2.7 17.4 14.1
Crime, theft, disorder 3.8 7.2 9.1 46.6 4.1 7.4 13.0
Inadequately educated workforce 6.4 7.4 14.0 25.9 0.3 11.3 10.9
Customs and trade regulations 2.0 5.7 6.6 34.2 3.0 4.9 9.4
Access to land 12.9 4.6 9.8 17.7 0.3 3.6 8.1
Telecommunications 3.1 4.9 16.3 13.0 4.0 3.9 7.5
Courts 1.5 8.2 6.7 13.0 1.1 13.9 7.4
Transport 4.1 3.7 5.4 22.7 2.0 4.6 7.1
Labour regulations 1.8 11.1 4.0 4.9 0.4 6.9 4.9
Business licensing and permits 3.5 8.4 5.1 4.6 0.3 3.7 4.3
Source: BEEPS V.

17
Unfair competition from the informal sector stands out as the most serious perceived
business obstacle in the region. More than 15 per cent of all firms cite it as the number one
obstacle, and more than one-quarter deem it a major or very severe obstacle. Other prominent
issues in the region include lack of access to finance, political instability, tax rates and tax
administration, and problems with electricity supply. The problem of corruption also crops up
prominently. Although few firms name it as the top obstacle, nearly 23 per cent of
respondents say it is a major or very severe problem.
The estimated monetary costs of some of these obstacles are substantial. The combined
losses from four obstacles whose impact is easily quantified – crime, corruption (that is,
informal payments to “get things done”), power outages, and transport breakages and
spillages – is estimated by BEEPS respondents at more than 13 per cent of total annual sales
revenues. This is well above most countries in central Europe and the Baltic states (CEB).
Considering that these four dimensions represent only a subset of the obstacles used in the
BEEPS questionnaire, the level of the invisible tax on output/productivity due to an
inadequate business environment is doubtless even higher.
Some obstacles are especially burdensome for small businesses. An econometric analysis
of the revealed costs of business environment deficiencies in the Western Balkans region
provides further insights.12 For example, unfair competition from the informal sector is a
particular burden for smaller, local market- and service-oriented businesses, and corruption
especially detrimental to more innovative firms. The problems of high tax rates and lack of
access to finance are more binding for firms in the manufacturing sector than in services. The
econometric results also permit a more rigorous ranking of obstacles based on a “benchmark”
company, taking into account the institutional setting of each country. However, the results
are broadly similar to those based on unconditional means (cited earlier) and, once again,
highlight the importance of tackling informality in the economy.
In general, the business environment for small businesses is particularly difficult. The
OECD’s SME Policy Index assesses SME policy frameworks against the 12 dimensions and
monitors progress in policy implementation over time.13 Progress is measured on a five-point
scale of policy development: level 1 implies that there is no law, institution, tool or service in
place to cover the area concerned, while level 5 indicates good practices in line with OECD
countries. Chart 11 shows the average scores of the six Western Balkans countries across the
12 dimensions, as well as their average – that is, the SME Policy Index – which is 3.07. This
means that on average there is a solid legal and/or institutional framework in place in the
Western Balkans, but no effective policy implementation. Some problematic areas include:
(i) SMEs in the green economy, (ii) entrepreneurial learning and women’s entrepreneurship,
(iii) innovation capacity, (iv) enterprise skills, (v) support services for SMEs and start-ups,
and (vi) bankruptcy and second chance for SMEs.

12
See Kresic et al. (2017).
13
See OECD, et al. (2016), SME Policy Index: Western Balkans and Turkey 2016: Assessing the
Implementation of the Small Business Act for Europe, OECD Publishing, Paris.

18
Chart 11 : SME Policy Index, average scores for the WB-6

Standards and technical regulations

Public procurement
Operational environment for SMEs
Regulatory framework for SME policy making
Access to finance for SMEs
Internationalisation of SMEs
SME Policy Index average
Bankruptcy and second chance for SMEs
Support services for SMEs and start-ups
Enterprise skills
Innovation
Entrepreneurial learning and women’s entr.
SMEs in a green economy

1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0

Source: OECD.

19
8. An assessment of transition qualities
Western Balkans countries lag behind the EBRD regional average in terms of progress
towards a sustainable market economy. During 2017, the EBRD undertook a major
exercise to quantify and measure progress in transition across the six qualities of a sustainable
market economy.14 The six qualities are: competitive, well-governed, green, inclusive,
resilient and integrated. The scores for the Western Balkans countries are presented in Table
5, along with the average across all EBRD countries, as well as those for the EU-11. The
results show most Western Balkans countries lagging behind in competitiveness and
governance, in common with the rest of the EBRD region. But the gap between the Western
Balkans and the overall EBRD region is fairly consistent across qualities, ranging from 0.3 to
0.5 points on the 1 – 10 scale. The difference in relation to EU countries in central and
eastern Europe is much more pronounced, with gaps ranging from 1.3 to 2.0 points. The
following sections consider each quality separately and the main factors determining the
scores across the Western Balkans region.

Table 5: Transition scores for six qualities of a sustainable market economy

Well-
Competitive Green Inclusive Resilient Integrated Average
governed
Albania 4.4 4.3 4.9 5.1 4.9 5.8 4.9
Bosnia and Herz. 4.7 3.7 4.8 4.8 5.3 5.5 4.8
FYR Macedonia 5.4 5.2 4.9 4.7 5.3 6.0 5.3
Kosovo 3.4 3.7 3.8 4.7 5.1 4.9 4.3
Montenegro 4.9 5.1 5.2 5.6 5.9 5.6 5.4
Serbia 4.9 4.4 5.8 5.2 5.6 6.4 5.4

WB-6 4.6 4.4 4.9 5.0 5.3 5.7 5.0

EU-11 6.5 5.7 6.3 6.3 7.3 7.5 6.6
EBRD 4.9 4.8 5.4 5.4 5.7 6.0 5.4

Source: EBRD.

14
The full scores for all countries and the associated methodology are presented in the EBRD Transition Report
2017-18, available online at: http://2017.tr-ebrd.com/. See also the annex to this paper for a summary of the
qualities and the scores for all EBRD countries.

20
Competitive
Western Balkans economies lack competitiveness, largely because of difficulties in the
business environment. Countries in this region typically score poorly relative to EU countries
on annual cross-country measures of competitiveness and the business environment such as
the World Economic Forum’s perceptions-based Global Competitiveness Index and the
World Bank’s Doing Business report. Enterprise surveys suggest that one of the biggest
obstacles to doing business is unfair competition from the informal sector. Other significant
obstacles include corruption, getting electricity and access to finance. Competitiveness is
also hampered in some countries by a still-large state presence in key industries and
inadequate implementation of the competition policy framework.

Chart 12 : Transition scores for Competitive

Source: EBRD.

Western Balkans countries score poorly on a broad cross-country measure of

competitiveness. The latest scores from the World Economic Forum’s Global
Competitiveness Index (GCI, Table 6), a perceptions-based measure of the concept of
competitiveness, show the clear gap between the Western Balkans region and the EU-11. On
average, the region is ranked 80th (ranging from FYR Macedonia in 68th to Bosnia and
Herzegovina in 103rd place), compared with an average 50th place for the EU-11.

21
Table 6: Rankings in Global Competitiveness Index 2017-2018
ALB BIH MKD MNE SRB WB EU-11
Global Competitiveness Index 75 103 68 77 78 80 50

1st pillar: Institutions 68 126 67 66 104 86 74

Basic 2nd pillar: Infrastructure 94 100 80 70 75 84 54
requirements
3rd pillar: Macroeconomic environment 75 64 44 116 72 74 33
4th pillar: Health and primary education 36 56 92 62 52 60 46
5th pillar: Higher education and training 49 91 76 61 59 67 45
6th pillar: Goods market efficiency 57 126 34 65 110 78 57
Efficiency 7th pillar: Labor market efficiency 91 123 95 74 92 95 67
enhancers
8th pillar: Financial market development 81 104 57 47 101 78 59
9th pillar: Technological readiness 78 69 61 48 72 66 38
10th pillar: Market size 105 97 110 128 74 103 65
Innovation and
11th pillar: Business sophistication 74 115 75 101 110 95 64
sophistication
factors 12th pillar: Innovation 87 123 51 91 95 89 62

Source: World Economic Forum’s Global Competitiveness Index Historical Database.

Several components of competitiveness are especially problematic. The region scores
reasonably well on indicators associated with the perceived quality of health and primary
education, as well as higher education and training (except for on-the-job training) and
technological readiness, such as information and communications technology (ICT) use.
However, the most problematic areas in the GCI, apart from market size, are: (i) labour
market efficiency related – namely, efficient use of talent (that is, capacity to attract talent
from abroad and, even more importantly, to retain talent), as confirmed by the “brain drain”
problem; and (ii) weak business sophistication, that is, the reliance on informal (family and
friend) relationships rather than on professional management, the lack of well-developed
business clusters, and shallow value chains. The largest difference in ranking between the
WB-6 and EU-11 is in the areas of macroeconomic environment (particularly emphasising
the challenging fiscal situation in the region compared with the EU-11), market size, business
sophistication, infrastructure development, innovation capacity and labour market efficiency.
The overall assessment on innovation is pulled down by low scores on company spending on
research and development (R&D) and the limited availability of scientists and engineers. For
instance, data from UNESCO show that, in per capita terms, the overall spending on R&D in
the region is just one-fifth of that in the EU-11, and way below EU levels. Transport
infrastructure ranks badly mostly due to the limited passenger-carrying capacity in airline
traffic, but also because of the poor quality of overall infrastructure, including roads, railways
and ports.
Problems in the business environment are persistent. The World Bank’s annual Ease of
Doing Business rankings vary widely in the region. FYR Macedonia is ranked 11th out of
190 countries in the 2018 report, the highest ranking in the region and the second highest
among all EBRD countries of operations. Kosovo, Montenegro and Serbia are ranked
between 40th and 43rd position, Albania is 65th, while Bosnia and Herzegovina is ranked the
lowest in the region at 86th position. However, the width of this ranking range exaggerates
the differences among the six countries. Common problems across the region include: dealing
with construction permits and getting electricity (see Chart 13).

22
Chart 13: World Bank’s Doing Business ranking, out of 190
100

90
WB-6 EU-11
90
80 85

70 65
61 74
73
60 69
62
47 57 58
50
47 48
40 44 47
39
30 37
35
32
20 26 28

10

0 10
Ease of Trading Resolving Getting Protecting Enforcing Registering Starting a Paying Getting Dealing with
Doing Across Insolvency Credit Minority Contracts Property Business Taxes Electricity Construction
Business Borders Investors Permits

Source: World Bank Doing Business 2018 report.

Competition from the informal sector is perceived as the biggest obstacle facing
businesses. As noted earlier, this finding emerges from the latest round of the EBRD/World
Bank Business Environment and Enterprise Performance Survey (BEEPS).15 When asked to
say which obstacle from a list of 15 represented the biggest problem for the establishment,
more than 15 per cent of firm owners and managers (on average) cited informal competition
as the main one.16 The problem is seen as especially damaging in FYR Macedonia (chosen by
26 per cent of respondents as the top obstacle), closely followed by Kosovo (23.3 per cent).
More than one-quarter of firms in the region rate the problem as “major” or “very severe”
(the two highest categories on a five-point scale).
Informal competition affects smaller, locally oriented firms in particular. An
econometric analysis linking the revealed cost of informality with observable characteristics
shows that the smaller the company, the more likely it is to find informal competition to be a
major problem.17 This is also the case for manufacturing (rather than service) companies and
those with a local, rather than international, orientation. Perceived costs of informality are
also higher for companies that have engaged in innovation in the previous three years.
Access to finance is among the major obstacles to doing business, according to BEEPS.
A quarter of all surveyed firms across the EBRD region described themselves as credit-
constrained, meaning that they need a loan but are either rejected when they apply for a bank
loan or feel discouraged from applying (see Chart 14). In the Western Balkans, the proportion
of firms credit-constrained is significantly higher on average. The main driver behind the
credit constraint was the discouraging level of interest rates at the time of the survey. Despite
the high number of banks in the region, competition among lenders appears to be limited and
SMEs in particular struggle to get the funds they need to grow their businesses. Other reasons
that discourage firms from applying for bank credit include: complex procedures, collateral
requirements and size of the loan (see Chart 15).

15
For results from the individual countries, see: “How the Western Balkans can catch up” by Peter Sanfey,
Jakov Milatovic and Ana Kresic, (EBRD Working Paper No. 185).
16
Krešić et al. (2017).
17
Krešić et al. (2017).

23
Chart 14: Share of credit-constrained Chart 15: Reasons why firms are credit-
firms constrained

Source: EBRD-World Bank BEEPS V, 2013. Source: EBRD-World Bank BEEPS V, 2013.

Entry and exit of firms are hampered by weak enforcement of competition policies.
Competition laws and institutions are in place, but the authorities in the region face major
challenges in building up sufficient capacity to respond to fast-changing environments.
According to the latest EC reports, the four candidate countries in the region (Albania, FYR
Macedonia, Montenegro and Serbia) can be considered as “moderately prepared” in this area,
while Bosnia and Herzegovina and Kosovo are at “some level of preparation” and “early
stage”, respectively.18
The region faces medium to large transition gaps in SME development. According to the
EBRD’s assessment of transition challenges, which captures the five dimensions of SME
development, including: (i) bank financing, (ii) the legal framework for bank finance, (iii)
non-bank financing, (iv) business skills and standards, as well as (v) the business
environment disproportionately affecting SMEs, Albania and Kosovo are assessed to have
large transition gaps, while the other four countries medium transition gaps. Two particularly
problematic dimensions are: (i) non-bank financing, and (ii) business skills and standards.

18
The 2016 European Commission reports on candidate and potential candidate countries are available at:
https://ec.europa.eu/neighbourhood-enlargement/countries/package_en.

24
Well-governed
Governance problems are pervasive throughout the region. The World Bank’s Worldwide
Governance Indicators show the largest distance between the Western Balkans and the EU
member countries lies in the rule of law. The distance is also large in the areas of control of
corruption, government effectiveness and regulatory quality. Evidence from the latest round
of the EBRD/World Bank Life in Transition Survey highlights the prevalence of the belief in
this region that political connections are key to success in life. With regard to corporate
governance, the EBRD’s Office of the General Counsel’s assessment of corporate
governance frameworks points to a number of deficiencies in Western Balkans countries that
would need to be addressed in order to meet best practice in this area.

Chart 16 : Transition scores for Well-governed

Source: EBRD.

All aspects of public governance lag behind EU standards. Using the World Bank’s
Worldwide Governance Indicators as a benchmark, the most problematic areas in the
Western Balkans are corruption, followed by the rule of law, government effectiveness and
political stability (see Chart 17). Voice and accountability and regulatory quality have the
highest scores, but good marks for the latter may reflect implementation of the EU acquis,
rather than genuine independence and capacity of the regulators.

25
Chart 17: The Worldwide Governance Indicators per category
1.50

1.00
Score [-2.5, 2.5]

0.50

0.00

2015: EU 2015: EU-11 2015: WB

-0.50
Regulatory Voice and Political Government Rule of Control of
Quality Accountability Stability Effectiveness Law Corruption

Source: The World Bank’s Worldwide Governance Indicators database.

Note: Scores range from -2.5 for weak governance performance to 2.5 for strong governance.
Governance scores have been improving. Although there is still some distance to go for the
WB-6 to match EU governance standards, a look at the scores over time suggests that the gap
is on average narrowing steadily (Chart 18). The biggest increase over the past 15 years has
been in political stability, with notable improvements also in rule of law and government
effectiveness. The smallest improvement in the scores has been in control of corruption.
Systemic corruption is a persistent problem. The latest EC progress reports assessed each
WB-6 country’s fight against corruption as being at “some level of preparation” (second
lowest point). The private sector also sees corruption as a major obstacle. In BEEPS V, 23
per cent of firms in the region deem corruption to be a major or very severe obstacle. The
costs of corruption, measured by per cent of annual revenue paid as informal payment to “get
things done”, are estimated at almost 1 per cent of annual sales, being the highest in Kosovo
and lowest in Bosnia and Herzegovina.19 Also, all countries are ranked relatively low on
Transparency International’s Corruption Perceptions Index (CPI), ranging from Montenegro
in 64th place to Kosovo in 95th out of 176 countries.20 The WB-6 average CPI score is 40 (on
a scale of 0 (worst) to 100 (best)), compared with an average of 65 in the EU (see Chart 19).
Chart 18: Change in average score for Chart 19: Corruption Perception Index
governance indicators 2000-15 Score 2016
0.8 100
Very Clean

-0.1
0.7 Difference between the 90
scores in 2000 and 2015
80
0.6
Country score in 2015 70
0.5
60
0.4 50
0.3 0.7 40
Highly corrupt

30
0.2
20
0.1 10
1.0
0.0 0

-0.1
EU EU-11 WB

Source: The World Bank. Source: Transparency International.

19
Krešić et al. (2017).
20
The Transparency International corruption perceptions scores are available at:
http://www.transparency.org/research/cpi/overview.

26
Political connections are seen by many people as key to success in life. According to the
third round of the EBRD/World Bank Life in Transition Survey (LiTS III), an average of
more than one-third of people in the Western Balkans rate political connections as more
important than either effort and hard work, or intelligence and skills, as the key to success in
life (see Chart 20).21 In this regard, the Western Balkans countries stand out among all EBRD
sub-regions, highlighting the absence of meritocratic job selection and prevalence of
clientelism and vested interests.
Chart 20: Political connections as a factor behind success

Source: EBRD/World Bank Life in Transition Survey III.

The corporate governance framework suffers from a number of weaknesses. The
EBRD’s assessment of corporate governance legislation and practices in the region points to
problems with stakeholders and institutions, structure and functioning of the board, internal
control, and disclosure (particularly of non-financial information). In addition,
environmental, health and safety, and social issues need to be integrated into corporate
governance practices to align with good international practice.22

21
EBRD (2016), Life in Transition: a decade of measuring transition, London, EBRD.
22
The EBRD corporate governance assessments, by country, are available at: http://www.ebrd.com/what-we-
do/sectors/legal-reform/corporate-governance/sector-assessment.html.

27
Green23
Countries in the Western Balkans face a range of environmental problems and challenges,
including air pollution, water and wastewater treatment, and sustainable waste management.
They are also increasingly affected by the negative consequences of global warming and
climate change. The incidence of extreme weather events and climate-related hazards has
increased noticeably during the past two decades. The expectations are that such trends will
continue and accelerate in the coming decades. Natural ecosystems, individuals and
economic growth will be affected by these changes. The recurrent floods that affected the
region in recent years had a very high economic cost in terms of damaged infrastructure and
housing, and more generally the disruption to economic activity across all sectors.

Chart 21 : Transition scores for Green

Source: EBRD.

Carbon intensity in the region is high but varies for each country (Chart 22). This is
attributable to several factors, including the degraded state of energy infrastructure, which
results in high energy losses in transmission and distribution, and inefficiency in end-use
sectors. The main domestic sources of electricity generation in the region are lignite (coal)
and hydropower. Serbia, Bosnia and Herzegovina, FYR Macedonia and Kosovo depend
mainly on lignite-fired thermal plants for electricity, while the power production from hydro
varies widely for each country (Albania 24 per cent and Kosovo 1 per cent), with the average
share standing at 12 per cent.

23
This section is based on an internal EBRD note: “Snapshot of green issues in the Western Balkans” by I.
Blanco and D. Chung.

28
Chart 22: Carbon intensity (kg CO2/2010 GDP PPP)
0.70

0.60

0.50

0.40

0.30

0.20

0.10

0.00
ALB EU-28 MNE MKD EBRD WB-6 SRB KOS BIH
Source: IEA.
Renewable energy provides a significant share of the region’s energy and is higher than
the EU-28 average (see Chart 23). Almost all of the renewable energy comes from large
hydropower plants; wind, solar and geothermal sources remain negligible at less than 1 per
cent of the total. All countries in the region are well endowed with biomass resources, mostly
used in the form of fuel wood in the heating and cooking sectors. However, this persistent use
of traditional biomass has harmful and damaging environmental and health effects and
highlights the need for replacement by modern biomass and renewable energy solutions for
both district and local heating purposes.
Chart 23: Share of renewable energy in primary energy production
50%
40%
30%
20%
10%
0%
MNE BIH ALB MKD WB-6 SRB KOS
avg

Hydro Biofuels/waste Geothermal/solar/wind

Source: IEA.
Sizeable energy saving potential exists. Potential savings can be found in the public (25 to
30 per cent), residential (10 to 35 per cent), service (10 to 30 per cent), industrial (5 to 25 per
cent) and transport (10 per cent) sectors.24 Final energy consumption is also relatively high:
when measured per unit of GDP (PPP-adjusted), the Western Balkans countries on average
consume 37 per cent more on average than the EU average, according to 2015 data from the

24
Financing Energy Efficiency Investment in the Western Balkans, https://www.energy-
community.org/dam/jcr:c15abf62-337e-42e9-99da-0d9c18db4f79/EECG112016_WBIF.pdf.

29
International Energy Agency. A study by the Energy Community has indicated that around
45 per cent (that is, 42,730,239 Mwh/year) of fuel consumed for heating houses and
apartment buildings can be saved if energy efficiency measures are implemented against the
current 94,725,532 Mwh/year used, translating to an estimated greenhouse gas emission
reduction potential of 43 per cent (that is, 15,855,830 tonnes CO2/year in total). Improving
energy efficiency will make these economies more competitive, while diverting resources
away from the energy sector towards other development priorities.
Progress towards EU standards in energy efficiency and renewables is being made. All
Western Balkans countries have undertaken to transpose the relevant EU directives in the
fields of energy efficiency and renewable energies, with implementation deadlines that vary
across countries. All are developing and implementing their second National Energy
Efficiency Action Plans (NEEAPs), which guide their activities towards meeting the
commitments under the Energy Community Treaty. Several Western Balkans countries
included exports in their National Renewable Energy Action Plans (NREAPs) and first
efforts to cooperate have started, in particular between Serbia and Italy. However, some
countries are currently lagging behind their commitments towards the Treaty. For example, in
Bosnia and Herzegovina there is no priority or guaranteed access for producers of renewable
energy, and the amount of wind capacity is very conservatively capped at 350 MW until
2019. Serbia, too, will likely miss the renewable energy share target for 2020 by one
percentage point, with investments in renewables being held back by feed-in tariff quotas
(500 MW for wind until 2020).
Climate change poses major challenges for the region. At present the Western Balkans
countries are some of the most water-rich in Europe but, according to almost all climate
models, this region will experience a significant decrease in precipitation during the 21st
century, accompanied by an increase in drought conditions and reduced water availability.
Annual flow reductions in the regions’ rivers of up to 15 per cent are projected for 2°C
warming above pre-industrial levels, and by up to 45 per cent if global temperatures increase
by 4°C. On the other hand, the risk of river floods is rising. Recent events have demonstrated
the vulnerability of the region’s population to floods. In May 2014, the equivalent of two
months’ rainfall arrived in just three days, causing extreme floods – the worst in 120 years for
Serbia – affecting an estimated 1.6 million people. In Bosnia and Herzegovina alone, the
economic loss caused by that flooding was estimated at 15 per cent of annual GDP.
Water quality is a cause for serious concern and improving water services will be a
major challenge. Wastewater treatment systems function badly and some urban areas do not
have a system at all. Many drinking water supply systems in the region are poorly maintained
and, in some countries, access to safe drinking water remains limited. Discharge of
wastewater is a major source of pollution for both surface and groundwater sources, and
wastewater treatment is often poor or non-existent. In many areas of the Western Balkans,
groundwater sources are at risk of contamination from agricultural run-off – the largest
contributor of nitrogen pollution – and other sources (World Bank, 2003). Mining sites in the
region have also contributed to water pollution through the release of heavy metals and
tailings. As countries in the region move towards the adoption of EU legislation such as the
Drinking Water Directive and the Urban Wastewater Treatment Directive, they will need to
meet higher standards for both drinking water supply and wastewater treatment.
Air pollution is a major problem. Air pollutants in the Western Balkans are at levels up to
two-and-a-half times the national air quality safety limits, and well beyond what the WHO
recommends. Bosnia and Herzegovina in particular has the highest level of ambient air
pollution in Europe (concentration of PM2.5), and the fifth highest rate of pollution related

30
mortality (92 deaths per 100,000) in the world. The extensive use in the region of wood
biomass for cooking and heating is another contributor to the low air quality. A study has
shown that public health costs from coal-fired power plants in five Western Balkans
countries, with seven of the 10 most polluting coal plants in the whole of Europe, may be as
high as €8.5 billion (US$ 9.4 billion) a year.25

25
http://climatenewsnetwork.net/coal-pollution-costs-western-balkans-dear/.

31
Inclusive26
Labour market reforms are needed to promote participation, address the skills deficit and
boost job creation. All countries in the Western Balkans suffer from severe regional
disparities, high levels of unemployment, especially among the youth, regular emigration
flows and low levels of labour force participation. Ageing populations pose a significant
challenge to long-term growth and the sustainability of social security systems.

Chart 24 : Transition scores for Inclusive

Source: EBRD.

Employers in the Western Balkans face significant problems in acquiring employees

with the required skills. In the BEEPS 2013-14 survey, 34 per cent of firms in the Western
Balkans reported that an inadequately educated workforce was an obstacle to current
operations, with one-third of these firms deeming the problem to be major or very severe.
More than half of all firms said that total annual sales would increase if this obstacle were
removed. Although the sectoral composition of skills mismatch varies across countries, the
needs are mostly concentrated in sectors within manufacturing and services, specifically
hospitality and agribusiness (see Table 7).

26
This section is based on an internal EBRD note: “Skills mismatch in the Western Balkans” by A. Dincer, and
on an EBRD-commissioned report: “School-to-Work transition in Western Balkans: Challenges and
opportunities”, prepared by a team from Ernst and Young and the BLIC Policy and Management Institute.

32
Table 7: Skills deficits in the Western Balkans
Inadequately educated Undersupplied sectors
workforce is a major or severe
obstacle to current operations
Agriculture and forestry,
Albania 6%
hospitality, food processing
Bosnia and Herzegovina 7% Health, ICT, hospitality
Hospitality, food services,
Montenegro 10%
construction
Manufacturing, trade,
Serbia 11%
construction
Automotive, trade, professional
FYR Macedonia 14%
activities
Services, manufacturing,
Kosovo 26%
agriculture
Source: BEEPS 2013-14; research of private placement agency (Posao.ba), Ministry of Education,
Science and Technology (Kosovo), Montenegro Employment Agency, Employer survey of National
Employment Service in Serbia, Gishti and Shkreli (2015, Albania), Skill Needs Analyses (2014,
Albania).
Labour forces in the region lack both hard and soft skills, industry knowledge and
practical experience. Due to the rapid development of technologies during the last decade,
there is high demand for hard skills, in particular the mastering of new technologies.
Additionally, surveys of the skill needs of employers, often undertaken by donor-funded
programmes, have identified important gaps in soft skills (communication, teamwork and
collaborative problem solving) in Western Balkans countries.27
Vocational education and training (VET) institutions struggle to flexibly adapt
education programmes, teaching methods and infrastructure to changing needs. These
factors impose limits on the quality provision of practical training and skills development
through VET institutions.28 This is a critical shortcoming which can be eliminated only
through practical training in enterprises. However, only a minority of businesses (41 per cent)
in the Western Balkans address skills mismatch through formal training programmes.
Employers typically invest relatively little in on-the-job-training, and private sector
involvement in skills policies remains limited.29
Young people have limited access to training and resources to establish their own
businesses. Only 28 per cent of young people indicate that they have access to training to
start and grow a business in the Western Balkans and only 22 per cent state that they have
access to finance. Scarcity of training and funding opportunities is particularly pronounced in
Bosnia and Herzegovina, where youth access to training and finance for entrepreneurship
stands at 13 and 8 per cent, respectively, the lowest amongst EBRD countries of operations.

27
Arandarenko, M., & Bartlett, W. (Eds.). (2012), “Labour market and skills in the Western Balkans”, FREN-
Foundation for the Advancement of Economics.
28
The severity of skills-related issue goes beyond the acquisition of technical skills. According to the OECD’s
PISA in 2015, the majority of 15 year old students in Albania, FYR Macedonia, Kosovo and Montenegro do not
possess basic mathematics skills (53, 70, 78 and 52 per cent, respectively, compared with 30 per cent at OECD.
In Serbia, which participated in PISA 2012, 39 per cent of the 15 year old student population, compared with 26
per cent in the OECD, did not reach the basic level in mathematics.
29
Arandarenko, M., & Bartlett, W. (Eds.). (2012).

33
Consequently, self-employment within the young labour force remains low at 11 per cent for
men and 7 per cent for women in the Western Balkans (see Chart 25). 30

Chart 25: Percentage of young people with access to training and finance to start and
grow business

Source: Calculations from Gallup World Poll (2013-2016).

Skills-related challenges make growth less inclusive. The slow rate of job creation, even in
times of economic growth, is a common feature of Western Balkans countries. For example,
five years of consistent economic expansion between 2004 and 2008 with an average annual
growth rate of 5.8 per cent was accompanied by high rates of unemployment. More
strikingly, during this period of economic boom the employment rate in Albania dropped
from 52 to 46 per cent and the youth unemployment rate in Kosovo rose from 67 to 73 per
cent. As a result, youth unemployment rates in the Western Balkans remain very high31 and
the private sector struggles to recruit skilled and motivated people. The resulting skills deficit
is of particular concern, creating real operational challenges for companies such as high staff
turnover and low productivity. Moreover, high levels of youth employment inhibit the
process of human capital formation and increase the dependency on support systems, which
puts an excessive burden on public finances in the form of higher social benefits.

30
Notably, young women are 49 per cent less likely to have access to training and 67 per cent less likely to
access to finance to start and grow business.
31
The percentages are: 29.2 per cent in Albania, 57.5 per cent in Bosnia Herzegovina, 49.5 per cent in Serbia,
55.3 per cent, 39.5 percent in Montenegro and 50.8 percent in FYR Macedonia (World Development Indicators,
2014).

34
Resilient
The region has shown significant resilience to various shocks in the past decade, but high,
although declining, levels of non-performing loans (NPLs) in the banking sector point to
ongoing vulnerabilities. NPLs are at double-digit levels (as a percentage of total loans) in
three of the six countries. Action plans are in place in most cases to address the problem,
supported by the EBRD and other IFIs within the framework of the Vienna Initiative.
Progress towards transposition and implementation of the Third Energy Package aimed at
liberalisation of the gas and electricity markets and empowering energy consumers varies
across the region.

Chart 26: Transition scores for Resilient

Source: EBRD.

Banking systems in the region have shown significant resilience during the crises of
recent years. The region’s banking sectors, all dominated by foreign-owned subsidiary
banks, have weathered the various crises well, helped by strong support from, and
coordination with, the international community. Foreign ownership of banking systems
ranges from about two-thirds in FYR Macedonia to 90 per cent in Kosovo (see Chart 27).
Italian and Austrian banks are among the largest in the region. They are followed by Greek
banks, which have a sizeable (although declining) market share in FYR Macedonia, Albania
and Serbia. French, Slovenian and German banking groups are also present in the region, as
well as OTP of Hungary, especially in Montenegro, and Turkish-owned banks, particularly in
Albania and Kosovo.
The combination of excessive pre-crisis lending, lax supervisory standards and a major
economic slow-down has left many banks with a high level of NPLs. Many banks are still
grappling with the legacy of NPLs. This is particularly the case in Serbia, Albania, and
Bosnia and Herzegovina, where the rates are still in double-digit levels, albeit on a declining
trend in all cases (Chart 28). All countries in the region are addressing the problem with the
support of the international community through the Vienna Initiative 2. Within this

35
framework, a dedicated workstream on NPLs has been launched, with the aim of improving
the transparency of restructuring frameworks, strengthening capacity through technical
assistance and increasing knowledge-sharing through a new NPL website.32

Chart 27: Ownership of banking assets Chart 28: Non-performing loans

25 Same period last year

20 Decrease in the last 12 months

NPL ratio Sep 17
15

10

-5

-10
KOS MKD MNE BIH SRB ALB
WB-6

Source: Bankscope. Source: National authorities.

Energy market reforms to transpose and implement the EU Third Energy Package have
progressed but are stuck in some countries. According to the Energy Community,33
Albania, Kosovo, Montenegro and Serbia have transposed the Third Energy Package to a
sufficient degree, although implementation of certain provisions remains a challenge.
Progress in Bosnia and Herzegovina and FYR Macedonia remains delayed. Only Albania has
so far successfully unbundled electricity and gas transmission system operators, although it is
yet to unbundle electricity distribution and retail. Almost no progress has been made in
Bosnia and Herzegovina and Serbia in terms of unbundling, despite the EC Secretariat having
initiated a dispute settlement case against Serbia in 2013. Effective energy market
liberalisation in the region will require bolstering of national authorities such as regulators,
which currently lack the strength and independence to push reforms in the face of national
players.
Dependence on electricity imports varies across the region. Albania, FYR Macedonia and
Kosovo are electricity importers. Given its high dependence on hydropower, Albania is
especially vulnerable to electricity import price spikes since rainfall is correlated regionally.
Montenegro and Serbia have a relatively even electricity balance, while Bosnia and
Herzegovina is the only power exporter in the region. At present, the region has a net
maximum electrical capacity of about 17,000 MW, almost evenly divided between
hydropower and thermo-power plants (coal-fired and gas/oil-fired – see Chart 29).
The region is highly dependent on Russian gas and its transit through Ukraine. In this
sense the Trans-Adriatic gas Pipeline (TAP), as well as the planned Ionian-Adriatic gas
Pipeline, are of the highest importance for the diversification of the region’s energy supply
routes and sources. TAP is designed to bring in around 10 bcma of natural gas from

32
See http://npl.vienna-initiative.com/.
33
Energy Community Secretariat (Feb 2018) ‘Knocking on the EU’s Door through the Energy Community:
Integration of Western Balkans into the Pan-European Energy Market’.

36
Azerbaijan via the Trans-Anatolian Natural Gas (TANAP) pipeline, Greece and Albania, and
across the Adriatic Sea to Italy. The TANAP/TAP pipeline could also be upgraded to almost
double capacity with compressor stations. In addition, the construction of the proposed 5 bcm
Ionian Adriatic Pipeline (IAP) from Albania, through Montenegro and Bosnia and
Herzegovina, to Croatia (the IAP would be linked with the Krk LNG terminal) would bring
natural gas to some areas of the region which are currently not gasified, such as Albania,
Montenegro and parts of Bosnia and Herzegovina. All countries, aside from Albania, have a
negative oil balance higher than 5 per cent of GDP (Chart 30).

Chart 29: Net maximum electrical capacity Chart 30: Oil and gas trade deficit, %
of power plants, MW, 2014 GDP

BIH MKD SRB MNE ALB

0

-2

-4

-6

-8

-10

Source: South-Eastern Europe Energy Source: Trade data: UNCTAD; GDP data: IMF
Community. WEO.

37
Integrated
Improvements in regional connectivity are required to strengthen cross-border trade and
investment links, and hence raise productivity. Current levels of trade and investment are
well below potential and are held back by weak connectivity links. The region’s needs for
improved transport and energy links are huge, but sources of finance are limited. A judicious
use of EU grants, IFI and bilateral loans (including from China, as part of the “Belt and
Road Initiative”), along with private sector investment, could make the region more
attractive to investors and exploit the region’s potential as an energy and logistics hub.

Chart 31: Transition scores for Integrated

Source: EBRD.

Foreign direct investment (FDI) has lagged well behind levels in the EU. A visible impact
of the global crisis was the sharp drop in FDI to the region, followed by a stagnating trend.
While Serbia is the biggest recipient of FDI in aggregate terms, Montenegro received the
biggest share of foreign capital in each of the last seven years in per capita terms. Still, the
region lags significantly behind the European Union in terms of FDI stock per capita
received; average FDI stock per capita in the Western Balkans is around €2,600 while in the
European Union it is around €14,300 (Chart 32).34 Even compared with the EU-11 average,
the Western Balkans region’s average FDI stock per capita is less than half that of the EU-11.
However, over the past five years, Albania, Kosovo and Serbia have all experienced annual
FDI inflows at a rate above the OECD average of 4.1 per cent of GDP, which is encouraging.

34
Authors’ calculations based on UNCTAD’s International trade database, 2015 – see Sanfey et al. (2016).

38
Chart 32: FDI stock per capita (€)

Source: IMF World Economic Outlook.

A more simple and reliable investment framework is needed to attract enhanced inflows
of FDI. All Western Balkans countries legally observe a level playing field between foreign
and domestic companies, but restrictions on foreign investments still remain. According to
the Heritage Foundation/Wall Street Journal Index of Economic Freedom, which summarises
information on areas where countries formally limit foreign investments, on a scale of 0 to
100 (with 100 representing a perfectly free country) Western Balkans countries score 67.5 on
average, while the EU scores 80.9. Additionally, problems often emerge not from the written
laws but their implementation and enforcement, which are much more difficult to measure.
International trade is below expectations, given the size, level of development and
geographical location. In terms of trade openness, defined as the sum of exports and imports
divided by GDP, the region lags behind central European and Baltic comparators, at 65 per
cent of the EU-11 level (Chart 33). Exporters in the Western Balkans typically face bigger
obstacles to doing business than those in comparator countries, including the poor quality of
infrastructure. According to the World Bank’s Doing Business report, the main difference
between the Western Balkans and the EU-11 (in the area of costs of trade) lies in the cost to
export, with that of the Western Balkans countries more than double that in the EU-11. Time
to export is also longer although the differences are less pronounced.
Challenges for both domestic and cross-border connectivity arise from the poor quality
of transport infrastructure. Years of neglect and under-investment have left even major
road and railway networks in a poor state. In the WEF’s GCI, the comparison with EU
countries highlights the extent of the challenge facing the region (see Chart 34). An analysis
of the sub-indices in the GCI suggests that the rankings are impaired by weaknesses of
railroads in all countries, as well as by the poor quality of roads in Bosnia and Herzegovina,
Montenegro and Serbia, inadequate (river) ports infrastructure in Serbia and Bosnia and
Herzegovina and limited air transport.

39
Chart 33: Trade share (% of GDP, 5-year Chart 34: Quality of infrastructure
average)

Source: UN COMTRADE and IMF WEO. Source: WEF’s Global Competitiveness Index.

Customs and trade regulations are a major problem for many exporters. The
bureaucracy associated with exporting or importing is often onerous. The time and costs to
trade are much higher compared with the EU-11 average. For instance, World Bank estimates
place the average cost to export in the EU-11 at US$ 34 per unit compared with US$ 65 in
Albania or US$ 232 in Kosovo. At the same time, average time to export in EU-11 is five
hours per unit, compared with six hours in Serbia or up to 66 hours in Kosovo (see Charts 35
and 36). Although the overall severity of this obstacle in the BEEPS is ranked low, the results
may be distorted by the large number of locally oriented firms which are not concerned with
this issue. Those firms with an international orientation tend to rank the obstacle much higher
as a problem for doing business.35

Chart 35: Time to trade, in hours Chart 36: Cost to trade, US dollars

KOS MNE

MNE BIH

ALB KOS

BIH MKD

MKD SRB
Time to import
SRB ALB Cost to import
Time to export
Cost to export
EU-11 EU-11

0 20 40 60 80 0 100 200 300 400 500

Source: World Bank Doing Business 2018 report.

35
Krešić et al. (2017).36 See OECD (2013), “Trade in Intermediate Goods and International Supply Chains in
CEFTA”, CEFTA Issues Paper 6.

40
The Western Balkans region is not well integrated into European supply chains. Results
from an OECD study indicate that the Western Balkans is integrated mostly into the final
stages of international supply chains in food, beverages and tobacco in addition to textiles
and clothing, and mostly the intermediate stages of wood and cork, paper, printing and
publishing, other non-metallic mineral products and fabricated metal products, as well as both
first and intermediate stages of basic metals.36 The product mix within the Western Balkans
countries also explains the limited integration to date into European supply chains. Over 50
per cent of the region’s manufactured goods are classified as “labour and resource intensive”
or “low-skill and tech intensive”, in comparison to about 30 per cent in the European Union.
In contrast, only 18 per cent fall into the category “high-skill and tech-intensive goods” in
comparison to 27 per cent in the EU-11.
Poor logistic performance is another bottleneck of economic development. The World
Bank’s Logistic Performance Index ranks 160 countries along six different dimensions of
trade. Chart 37 illustrates the gaps in Western Balkans countries in comparison to the EU-11
regarding all sub-indices. The efficiency of customs and border management, the quality of
trade and infrastructure and the ease of arranging competitively priced shipments (here
averaged as an indicator for cross-border transport) are below the EBRD average of 2.7 in all
Western Balkans countries.
Chart 37: Logistic Performance Index

Source: WB, LPI database.

Access to electricity remains a major barrier to business development. Similar to
transport, the energy sector in the Western Balkans has been plagued for many years by
under-investment, poor management and a non-commercial approach to operations, and the
gaps in quality relative to EU countries are large. Access to electricity emerges from an
econometric analysis of the BEEPS as one of the top three obstacles for a representative firm
in the region.37
Energy market integration has stalled, despite the fact that the countries’ infrastructure
in the electricity sector is relatively well interconnected. Given the small size of national
energy markets, the Western Balkans countries will not be able to develop liquid markets in
isolation. Cross-border cooperation is therefore essential for achieving important cost savings
for energy consumers through increased competition and more effective use of existing

36
See OECD (2013), “Trade in Intermediate Goods and International Supply Chains in CEFTA”, CEFTA Issues
Paper 6.
37
Krešić et al. (2017).

41
generation and transmission infrastructure in the region. However, with the exception of a
common platform for coordinated allocation of electricity cross-border capacities, SEE CAO,
there has been little progress in cross-border cooperation. For example, according to the
Energy Community, with the exception of Serbia, the Western Balkans countries are yet to
establish functioning power exchanges. Cross-border electricity trade is therefore below the
region’s potential, reflecting the high level of market fragmentation.38 The lack of cross-
border cooperation between the WB-6 and EU member states is also highlighted in the
European Commission’s Enlargement Strategy 2025 for the region as a key barrier to
expanding the EU’s Energy Union to the region.
Chinese investment in the Western Balkans is growing in importance. China views the
Western Balkans as an important component of its ambitious “Belt and Road” initiative.
Major investments with Chinese sponsors have occurred or are under way in the transport and
energy sectors in Bosnia and Herzegovina, FYR Macedonia, Montenegro and Serbia. This
funding, combined with a streamlined approval process and speedy implementation, is
proving attractive to Western Balkans countries because the region’s major investment
funding needs cannot be fully met by EU pre-accession grants and IFI lending.39 In April
2017, the China-CEE Institute became the first think-tank independently registered in Europe
by a Chinese institution to produce research related to the “16+1” cooperation between China
and central and south-eastern Europe and the Belt and Road initiative.

38
Energy Community Secretariat (February 2018) Knocking on the EU’s Door through the Energy Community:
Integration of Western Balkans into the Pan-European Energy Market.
39
For further discussion, see O. Levitin, J. Milatovic and P. Sanfey, “China and South-Eastern Europe:
Infrastructure, trade and investment links”, EBRD focus piece, 2016, available at:
www.ebrd.com/documents/comms-and-bis/see-china-investments.pdf. See also J. Bastian, “The potential for
growth through Chinese infrastructure investments in Central and South-Eastern Europe along the “Balkan Silk
Road”, independent report prepared for the EBRD, 2017, available at: www.ebrd.com/documents/policy/the-
balkan-silk-road.pdf.

42
Annex: the six transition qualities – summary and scores

1. Competitive – Open economic systems that function well are built on dynamic and
competitive markets. The notion of a “competitive” economy lies at the heart of the
transition process. It represents a core characteristic underpinning the move from a
state-driven, top-down mechanism to one which is more flexible and responsive to
market signals.

2. Well-governed – One of the important lessons of the EBRD’s first 25 years has been
that transition is not just about building markets and the private sector. It is also about
improving the quality of both state and private sector institutions and ensuring that
they work well together. Governance is about the quality of institutions and the
processes that they support. Therefore, the definition of this quality acknowledges the
crucial role of governance at the level of an economy as well as at the level of the
corporate.

3. Green – The green dimension of environmental sustainability is an integral quality of

transition within a sustainable market economy, implying that economic decisions
should reflect the full value of resources to present and future generations.

4. Inclusive – Economic inclusion, the opening up of economic opportunities to

previously under-served social groups, is integral to achieving transition towards
sustainable market economies. An inclusive market economy ensures that anyone –
regardless of their gender, place of birth, socio-economic environment, age or other
circumstances – can access labour markets, entrepreneurship and, more generally,
economic opportunity. Promoting an inclusive market-based system is therefore about
the efficient allocation of human resources within an economy rather than social
policy.

5. Resilient – A resilient market economy supports growth while avoiding excessive

volatility and lasting economic reversals. It is about the ability of markets and market-
supporting institutions to resist shocks, and about balance and sustainability in
financial and economic structures. Because a well-functioning financial system is
central to a sustainable market economy, financial stability is the most important
element. This quality also considers food security and energy sector resilience.

6. Integrated – Integration is a central element in any economy’s competitiveness. It

enables trade at greater speed, lower cost and better quality and supports competition
in product and services markets. As a transition quality, integration refers not only to
the physical dimension (such as larger cross-border projects in major transport or IT
networks), but also improvements to domestic markets through national-level
enhancements of ports, airports, cities and rural areas.

43
Transition scores for six qualities of a sustainable market economy
(scale: 1-10; countries ranked by simple average of the six scores)

Well-
Competitive governed Green Inclusive Resilient Integrated
Sweden 8.72 9.11 7.49 7.93 7.83 8.36
Germany 8.43 8.66 7.39 7.27 8.41 8.23
United States 8.72 8.63 6.09 6.64 8.93 7.39
Estonia 7.58 7.58 6.44 7.30 8.19 7.77
Czech Republic 6.83 6.28 6.62 6.41 8.07 8.25
Slovenia 6.93 5.74 6.67 7.02 7.44 7.61
Latvia 6.53 6.09 6.37 6.82 7.66 7.73
Lithuania 6.06 6.10 6.06 7.05 7.23 7.78
Slovak Republic 6.82 4.98 7.05 5.73 7.64 7.85
Poland 6.38 6.15 6.56 6.29 7.64 6.79
Hungary 6.42 5.31 6.37 6.27 6.65 7.89
Croatia 5.75 5.14 6.03 6.03 6.61 6.85
Cyprus 7.21 6.15 5.76 6.20 5.19 6.52
Romania 6.28 4.97 5.86 5.08 6.98 6.88
Greece 6.31 4.34 6.27 5.63 6.67 6.38
Bulgaria 5.96 4.69 5.82 5.33 6.54 6.86
Turkey 4.89 5.30 5.12 4.21 7.08 5.90
Georgia 4.54 5.98 4.58 5.14 5.71 6.54
Montenegro 4.89 5.12 5.15 5.62 5.93 5.59
Serbia 4.94 4.39 5.77 5.16 5.55 6.39
Russia 5.20 4.55 4.92 5.94 5.95 5.17
Jordan 3.92 5.26 5.65 4.88 5.66 6.12
Macedonia FYR 5.39 5.20 4.91 4.72 5.31 6.04
Armenia 4.47 4.79 5.41 5.72 5.04 5.94
Belarus 4.99 4.32 6.16 5.72 4.17 5.38
Mongolia 4.25 4.50 5.28 5.64 4.57 5.68
Kazakhstan 4.30 5.05 4.42 5.37 5.66 5.00
Morocco 3.98 4.35 5.47 4.16 6.06 5.45
Ukraine 4.68 3.58 5.54 5.88 4.60 5.04
Albania 4.41 4.31 4.85 5.11 4.86 5.76
Moldova 4.87 3.94 4.14 5.19 5.27 5.64
Bosnia and Herzegovina 4.74 3.66 4.85 4.83 5.35 5.47
Azerbaijan 3.64 4.61 5.23 4.71 4.46 5.84
Tunisia 3.94 4.33 4.78 4.72 4.75 4.70
Kyrgyz Republic 3.45 3.33 4.36 4.46 4.98 4.94
Kosovo 3.37 3.73 3.80 4.70 5.09 4.89
Egypt 2.87 3.90 4.41 4.24 5.41 4.27
Tajikistan 2.66 3.69 5.58 4.58 3.76 4.23
Uzbekistan 2.72 4.32 3.20 5.34 3.98 4.20
Turkmenistan 1.46 3.83 4.13 4.86 3.12 4.64
Lebanon 4.92 TBD TBD TBD TBD 5.82
Source: EBRD.

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