How economic integration can increase living standards in the Western Balkans

Economic theory and international experience show us that small countries get richer when deeply integrated into the global economy. Economic integration can facilitate access to a larger consumer base, a greater pool of qualified workers, additional sources of financing, and new technologies. A larger market, with an even playing field in which all firms can compete, can shake up sclerotic industries captured by closely-connected local political and business elites as well as encourage innovation. In other words, economic integration can create an environment for existing firms to grow, become more productive, or exit the market, and for new firms to emerge and succeed or fail fast and cheap.

This is particularly important for the small economies of the Western Balkans (Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia), which continue to lag behind the income levels achieved by other similar-sized, but generally more open, economies. As shown in Figure 1 below, among small countries in Europe and Central Asia, high income per capita is closely correlated with trade openness. As population increases, the link between trade openness and high income per capita weakens. Nonetheless, even for an economy of Serbia’s size, following the development path of open economies like Hungary, Belgium, and the Czech Republic is a promising option.

Figure 1: Among small countries in Europe and Central Asia, high income per capita is closely correlated with trade openness

Source: World Development Indicators 2017; European and Central Asia (ECA) economies with population less than 12 million; excluding Luxemburg; income is measured as GDP per capita, PPP (constant 2011 international $)

While the six economies of the Western Balkans have made major progress toward opening their economies since the fall of the iron curtain, they continue to trail regional peers. Typically, as small economies join the ranks of high-income countries, exports expand toward 100 percent of national income or more. In the Western Balkans, however, the average ratio of goods and services exports to GDP is about 40 percent in 2017 (up from about 25 percent in 2000 and 30 percent in 2010). That is still behind levels achieved by Latvia (about 60 percent), Cyprus (about 65 percent) and Estonia (about 80 percent)—countries similar in population size but having achieved significantly higher income per capita in the last two decades.

What is holding back the Western Balkans? In part, it is historical legacy factors—such as a relatively limited productive base that now needs to be nurtured and conflicts that have affected regional trade. However, policies and institutions play a key role, and much can be done to improve both.

In 2017, recognizing the unrealized potential of economic integration as a means for economic growth, the Western Balkans initiated a joint Multi-Annual Action Plan (MAP) to develop a Regional Economic Area (REA). This initiative promotes regional economic integration among the Western Balkan countries and aligns regional legal frameworks and infrastructure with the requirements for eventual EU accession, to help full integration into the EU value chains. The MAP covers four dimensions of economic integration: trade, investment, mobility, and digital integration.

Progress has been achieved since the MAP was adopted, and it is crucial that Western Balkan countries continue with its decisive implementation. Besides upgrading physical infrastructure and aligning tariffs, nontariff obstacles to trade need to come down—including streamlined border crossing procedures. National investment frameworks need to be aligned to offer seamless access to a regional market with reduced obstacles to investor entry, better investor protection, streamlined policies for attracting investors, and, perhaps most important, better positioning of the region for integration into global supply chains. To make the Western Balkans a more attractive value proposition for highly skilled workers, key initiatives include making mobility simpler for researchers; mutual recognition of professional qualifications, such as those of doctors, dentists, architects, and engineers, and mutual recognition of academic qualifications. Together with national reforms of education, these measures can help tackle the regional skills gap and help workers to move to places with the highest job creation potential. Finally, the Western Balkans can seize the opportunities created by the digital revolution. Doing so will include the elimination of regional roaming charges, a unified approach to digital security and data protection, promotion of digital skills, and affordable and accessible high-speed broadband.

The stakes are high, but economic integration may be the key to the higher living standards the Western Balkans aspire to. Income per capita in the Western Balkans is still only 28 percent of Germany’s; at current growth rates, it will take five decades for the region to reach Germany’s current standard of living. New opportunities are needed to speed up growth—which means overcoming small and fragmented national markets. With a shared vision to ensure macroeconomic stability, carry bold reforms beyond borders, and enhance economic integration, the Western Balkans stand a chance to accelerate growth, improve living standards, and reap the benefits of the new global economy.

Copyright 2018 The Brookings Institution

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