Economic Performance in South- East European Transition Countries After the Fall of Communism

Copyright © 2014 by Tahir Mahmutefendic.

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CONTENTS

Acknowledgments

List of Tables

List of Abbreviations

Preface

Introduction

Chapter 1 – Economic Performance In South-East European Countries 2001-2003

Chapter 2 – Macroeconomic Dynamics In The South East European Transition Economies In 2004

Chapter 3 – Intra-Regional And Inter-Regional Trade In South-East European Transition Economies

Chapter 4 – Economic Performance In South-East European Transition Countries In 2005

Chapter 5 – Economic Performance In South-East European Transition Countries In 2006

Chapter 6 – Economic Performance In South East European Transition Countries In 2007

Chapter 7 – The Economic Performance Of South East European Transition Countries In 2008

Chapter 8 – Recession In 2009 And Its Impact On – The See Transition Countries

Chapter 9 – The Recovery In South-East European Transition Countries In 2010?

Chapter 10 – The Impact Of Transition On Welfare And Distribution Of Income In South-East European Countries

Chapter 11 – Conclusion

Bibliography

Appendix 1

Appendix 2

Appendix 3

Endnotes

Dedicated

To Ekbal and Moenes

ACKNOWLEDGMENTS

I owe a debt of gratitude to the following individuals:

Dr Eric Beckett Weaver, Editor in Chief of the South Slav Journal

Nemanja Marcetic, Honorary President of the South Slav Journal and former editor in Chief of The South Slav Journal

Pat Taylor, former Deputy Editor in Chief of The South Slav Journal

Edward Alexander, translator from Bosnian/Croatian/Serbian to English

Miro Ivanovic, ICT manager at CISCO

Finally, I owe my gratitude to those to whom this book is dedicated

LIST OF TABLES

Table 1—Economic Growth in the Balkan Countries in 2004

Table 2—Foreign Direct Investment in the Balkan Countries in 2004

Table 3—Unemployment Rates in the Balkan Countries in 2004

Table 4—Inflation Rate Measured by Consumer Price Index

in the Balkan Countries in 2004

Table 5—Balance of Payments in the Balkan Countries in 2004

Table 6—External Debt in the Balkan Countries in 2004

Table 7—Share of Trade in GDP, 2002 (%)

Table 8—Percentage of exports and imports to other

SEE countries, 2002

Table 9—Share of the EU in SEE exports and imports (% 2002)

Table 10—Growth of the world output in 2007

Table 11—Selected economic indicators 2009/2010

Table 12—Growth and composition of credit and currency

composition of loans, by country, March 2009

Table 13—Percentage of the population in South-East European

transition countries living in absolute poverty using international poverty standards

Table 14—The economic situation is better today than in 1989

(Per cent of respondents)

Table 15—Relative Levels of GDP per Capita

LIST OF ABBREVIATIONS

AD—Aggregate Demand

AVNOJ—The Antifascist Council of National Liberation

BiH—Bosnia and Herzegovina

C—Consumption

CDO—Collateral Debt Obligation

CEBS—Central European and Baltic States

CEFTA—Central European Free Trade Area

COMECON—The Council for Mutual Economic Assistance

CPI—Consumer Price Index

CPF—Croatian Privatization Fund

EC—The European Commission

EBRD—The European Bank for Reconstruction and Development

ECB—The European Central Bank

EFTA—The European Free Trade Area

EIB—The European Investment Bank

EU—The European Union

ERM—Exchange Rate Mechanism

FBIH—Federation of Bosnia and Herzegovina

FDI—Foreign Direct Investment

FI—Foreign Investment

FTA—Free Trade Agreement

FRY—The Federal Republic of Yugoslavia

FYR Macedonia—The Former Yugoslav Republic of Macedonia

G—Government Expenditure

GDP—Gross Domestic Product

I—Investment

ICT—Information and Communication Technologies

ILO—The International Labour Organization

IMF—The International Monetary Fund

IPO—Initial Public Offerings

K—Multiplier

M—Imports

Mb—Monetary Base

MCI—Monetary Conditions Index

MPC—Marginal Propensity to Consume

Ms—Money Supply

NAFTA—The North American Free Trade Area

NASDAQ—North American Stocks, Dividends and Quarterly

NATO—The North Atlantic Treaty Organization

OECD—The Organization for Economic Co-operation

OPEC—The Organization of Petroleum Exporting Countries

OPT—Optimal Purchasing Technique

PTA—Preferential Trade Agreement

R—Monetary Reserve Ratio

RPI—Retail Price Index

RS—Republika Srpska

SEE—South East Europe

SEEREM—South East European regional Electricity Market

SWF—Sovereign Wealth Fund

T-Bills—Treasury Bills

UK—United Kingdom

US—United States

USA—United States of America

VAT—Value Added Tax

WTO—World Trade Organization

X—Exports

PREFACE

South East Europe is another name for the Balkans. The Balkans is a Turkish word meaning a mountain covered in forest. The region comprises the former Yugoslavia, Romania, Bulgaria, Greece, Albania and the European part of Turkey. The Balkans is one of the three peninsulas in Southern Europe. Unlike the other two, the Iberian and the Apennine, which are religiously and culturally homogeneous, the Balkans have always been a crossroads of civilisations and a mosaic of different religions, cultures, nations and ethnicities. This has been the cause of bloody conflicts throughout history. In addition the Balkans have always been the poorest region in Europe, with the possible exception of the 1960s, during which a successful economic development placed Greece and Yugoslavia near the bottom of the list of developed countries.

The Balkans were deeply divided in the aftermath of the Second World War. The regions heterogeneity was four-fold. The countries of the Balkan Peninsula had different internal political system, external political links and associations, different economic systems and different patterns of economic links with the rest of the world.

1. Greece and Turkey were mainly capitalist countries and parliamentary democracies and with multi-party political systems, which were on two occasions interrupted by military dictatorships. The other four countries, namely Albania, Bulgaria, Romania and Yugoslavia were communist countries with one-party system.

2. From the point of view of external politics the Balkans were even more divided. Greece and Turkey were members of NATO. Romania and Bulgaria were members of the Warsaw Pact. Yugoslavia was a non-aligned country, whilst Albania did not belong to any pact or association of countries. It had intensive links with the Soviet Union until 1961 and, after this point with China.

3. Greece and Turkey were market economies with their governments playing a large role in their economies, Bulgaria and Romania were centrally planned economies. Yugoslavia was a semi-market economy, containing elements of both the systems.

4. Greece and Turkey were the members of OECD and had the most intensive economic links with capitalist countries. Romania and Bulgaria were the members of COMECON and had the most intensive economic relationships with the other communist countries. Yugoslavia was the most open communist country with intensive economic links to both East European and West European countries, especially the Soviet Union, West Germany and Italy. Albania was a closed country with a negligible level of economic relations with the rest of the world.

Political and economic fragmentation is at the same time one of the causes and consequence of backwardness. The collapse of communism was viewed by some as a golden opportunity to integrate the region and turn it into a prosperous part of Europe. The introduction of parliamentary democracy, multi-party systems and free elections politically unified the region. Transition from centrally planned economy and in the case of Yugoslavia from a semi-market economy to a market economy had, amongst others the aim of removing the differences in economic systems which existed between the region’s countries. Various initiatives such as the Stabilisation and Association Pact and bilateral trade agreements were supposed to beef up the weak relations which existed between the region’s countries. The possibility of European Union and the NATO membership was supposed to act as a carrot, the aim of which was to integrate the Balkans into the wider European economic and political frameworks through dynamic economic expansion.

The international community supported transition in the Balkans by providing political, technical and financial aid. Individual countries, the European Union and international financial institutions gave tens of billions of dollars with the aim of stabilizing and integrating the Balkans and turning it into a prosperous European region.

It has been more than two decades since the beginning of the transition. This seems to be a sufficiently long period to analyse and assess the transition’s achievements.

This book has eleven chapters. The first one analyses economic performance in South-East European countries during the period of 2001-2003. There were two reasons why this has been treated as a single period Firstly, this was the beginning of economic transition for the whole region in which the dynamics of internal factors prevailed and the transitional countries of South East Europe were only marginally affected by the external environment. Secondly, data and sources for this period can be scarce and sometimes contradictory in nature (this might, however, be the case for the later period, albeit to a lesser extent).

The second chapter deals with macroeconomic dynamics in SEE transition countries in 2004.

The third chapter follows the patterns of intra-regional and inter-regional trade in SEE transition countries.

The chapters four to seven analyse economic performance in SEE transition countries from 2005 to 2008, a period of un-interrupted prosperity.

Chapters eight and nine deal with the recession in the world economy in 2009 and its impact on SEE transition countries and the fragile recovery which followed in 2010.

The chapter ten analyses the impact of transition on welfare and distribution of income in SEE transition countries. It ends with a subjective assessment of the transition. This links to the last chapter entitled ‘The Results of Transition are disappointing-Was Communism altogether Bad? The last chapter calls for a more balanced assessment of the two economic and political systems.

The South-East European transition region comprises most of the former Yugoslavia, namely Bosnia and Herzegovina, Macedonia, Montenegro and Serbia Romania, Bulgaria and Albania. Although part of Slovenia’s territory belongs to the Balkans historically, culturally and according to its level of development the country belongs to Central Europe. To a lesser extent, the same applies to Croatia as well. However, Croatia shares some characteristics with South-East Europe. This is why Croatia is sometimes classified as a Central European and sometimes as a South-East European country.

In 1992, Serbia and Montenegro declared a new state The Federal Republic of Yugoslavia. The state remained under this name until 2002, when it was transformed into a loose union called Serbia and Montenegro in which Serbia retained the dinar as its currency whilst Montenegro unilaterally introduced the euro. In 2006 Montenegro seceded and became an independent state. This is why, until 2006 there were seven countries and after 2006 eight countries South-East Europe; Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Montenegro, Romania and Serbia.

INTRODUCTION

At the end of the 1980’s, the economies of communist countries were in a dismal condition. The major problems stemmed from the following:

• Large, inefficient, subsidised state-owned enterprises

• An illiquid banking sector due to financing inefficient state-owned enterprises

• Huge fiscal deficits due to subsidies and soft budget constraints

• A distorted price structure which led to the misallocation of resources

• Shortages of some goods and surpluses of other which were of a low quality and a narrow choice

• A black market which offered goods which were in shortages at exorbitant prices

• Excess employment/artificial full employment which added to the inefficiency of state-owned enterprises

Out of all of the communist countries, Yugoslavia was in the best condition. This was due to the following factors:

• A semi-market self-management economy with a high level of industrial democracy

• Various types of pluralism non-existent in the other communist countries

• By far the largest private sector which accounted for about 25% of the Social product

• Open borders, which enabled its citizens to travel abroad and become familiar with practices in the West

• A great number of citizens who worked in Western European countries, providing remittances, which helped to reduce the balance of payments deficit and increased the standard of living

• The highest standard of living in Eastern Europe

• A constitution which did not forbid the formation of political organisations. Therefore, only minor adjustments in the constitution and changes in law were required to introduce a multiparty system instead of a complete legal overhaul

It was expected that the transition to a market economy would be easiest for Yugoslavia. It was also expected that Yugoslavia would be the first country to join the European Union. Unfortunately, the violent break-up of the country put Yugoslavia behind almost all of the other communist countries in the transition process.

The plight of the South- East European countries did not finish with the end of war in Croatia and Bosnia and Herzegovina in 1995. The wars of Yugoslav succession had their sequel in 1999 when NATO waged a 78-day war against Serbia. The war destroyed Serbia’s infrastructure and temporarily severed economic links between a several South- East European countries.

The other three countries also experienced severe difficulties during the 1990’s, fraught with political scandals in Bulgaria and Romania and a financial scandal in Albania linked to a pyramid scheme scam. Almost the whole decade was lost for most of the region. In the words of John Kenneth Galbraith, one strong and imperfect system was replaced by the absence of any system. As a result transition had a different path from the one experienced by Central European and Baltic States. While the former experienced a V-shape change in output (recession followed by recovery) the latter recorded a W-shape of change in economic performance (recession followed by recovery, followed by recession and finally recovery)

At the beginning of the 21st century, all of the South East- European countries embraced reforms aimed at transforming their countries to free market economies. These reforms went through three stages: market-enabling, market-deepening and market-sustaining. Market-enabling reforms are the easiest and quickest to implement. They include price, domestic and foreign trade liberalization and a privatization of small enterprises. Market-deepening reforms include the privatization of large companies and assets and the strengthening of banking and non-banking financial institutions such as leasing, pension and equity funds. Market-sustaining reforms are the most difficult to carry out. They involve governance and enterprise reforms, competition policy and infrastructure reform in five sectors—electricity, railways, roads, telecommunications, and water (including waste water). They also cover issues such as commercialization, tariff reforms, quality of the regulatory framework and involvement in the private sector.

With the first and second stages of the reform firmly in place and with the flow of aid and loans from the West, in a global environment of cyclical upturn in the world economy, the South East European countries experienced a vigorous and sustained growth from 2000 to 2008, before the recession in 2009. Transition to free market economy has so far produced positive and negative results.

Positive results are evident in the following:

• More dynamic growth than in Central European and Baltic States and the European Union. This has enabled some catching-up to take place, however there is still a huge difference in the level of development and many decades of successful economic development are needed in order to achieve a full real convergence

• A prudent monetary policy which was successful in tackling inflation and decreasing it to historically lowest levels

• Sound exchange rate policy, whether in the form of currency board, pegging currency to the euro, unilateral adoption of the euro or managed floating. This policy brought stability and in some cases the appreciation of the real exchange rate

• A prudent fiscal policy which brought government balances into range between moderate deficits and moderate surpluses. In this respect South-East European countries fare better than most of the other European countries

Negative results are most evident in the following:

• Large external imbalances which increase the vulnerability of South East European countries and their dependence on foreign sources of finances,

• Rising foreign debt which in some countries is approaching unsustainable levels

• High and persistent unemployment which in some countries reaches forty percent of the workforce

• A widening gap between rich and poor and a sharp increase in absolute poverty

It is these last two items which are the main cause for concern and the main reason for widespread dissatisfaction with the transition.

CHAPTER 1

ECONOMIC PERFORMANCE IN SOUTH-EAST EUROPEAN COUNTRIES 2001-2003

1. GLOBAL ECONOMIC PERFORMANCE

The new millennium began with the slowing down of the rate of growth of world output. The deterioration in the performance of the world economy started with a recession in the USA. The recession was caused mainly by three factors: the bubble bursting in the technological sector, corporate scandals combined with so called creative accounting and widespread deregulation especially in the banking sector.

• The technological sector, led by the telecommunications industry, was the main pillar of almost unprecedented prosperity in the American economy during 1990’s. In the course of less than a decade, it almost doubled its share in the economy and accounted for two thirds of new jobs and one third of new investments. ‘Irrational exuberance’, an expression coined by Alan Greenspan, the former chairman of the Federal Reserves, to describe faith in the infinite rise in share prices, led to overinvestment in telecommunications companies with big giants vying for a monopoly. The NASDAQ index, comprised mostly of shares in the technology sector, rose