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What is holding back the Western Balkans economies?

By Peter Sanfey

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What is holding back the Western Balkans economies?

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Grey economy, politics, taxes and electricity named as obstacles to business

Countries in the Western Balkans have strong growth potential, which can be realised with the right investment and a better business environment. But life remains difficult for firms and households: GDP per capita in this part of Europe is about half that of Poland, Hungary and other eastern European countries, and a mere quarter of the richest EU members in western Europe.

The speed of catch-up in the coming years will depend on how quickly countries can tackle the problems that hold back the region’s private sector and prevent it from developing its full potential. So, what are the biggest obstacles that face businesses in the Western Balkans in their day-to-day operations and is the situation improving? To answer these questions, one can use the business environment and enterprise performance surveys carried out every few years by the EBRD and World Bank.

Some of the results from the most recent round of this EBRD-World Bank BEEPS survey are encouraging. According to these findings, firms have noticed a marked improvement in licensing, courts, telecommunications and some other areas compared with 2009. But a number of serious obstacles remain.   

One such problem stands out as particularly onerous – unfair competition from the informal sector. One in four firms see this as a major or a very severe obstacle. Legitimate businesses in this part of the world face a heavy burden of taxation and social insurance payments, and sometimes an onerous inspection regime, and they complain bitterly when some of their competitors avoid these costs and constraints. The problem is a long-standing one in the region and is difficult to tackle effectively. Nevertheless, that has not stopped countries trying, and the improvement of several countries recently in the World Bank’s ease-of-doing-business ranking is testament to efforts to encourage businesses to register and belong to the formal economy.

Other major business obstacles for firms in the Western Balkans include political (in)stability, access to finance, tax rates, corruption and reliability of electricity supply. Political instability and corruption were seen by almost one quarter of firms as a major or a very severe obstacle. One in five firms rated electricity issues, tax rates and access to finance also as highly problematic. On average, firms in the Western Balkans lose 13.2 per cent of their annual sales due to a combination of crime, electricity issues, poor transport infrastructure and corruption (four obstacles whose impact is easily quantified). This compares unfavourably with eastern European countries within the European Union, where the same impact was below 10 per cent. Business obstacles are costly also in terms of time: managers report that they spend on average almost one day per week dealing with government regulations. This is a major burden and distracts them from more productive activities.

It’s not all doom and gloom though; some aspects of the business environment are improving. If one compares the results from the most recent round of the survey with the previous round in 2009, it is clear that areas such as business licensing and the functioning of the courts are less of a problem than before. For example, an e-permitting system was introduced in Serbia in 2016 that reduced the time needed for construction permits and allowed Serbia to jump from 152nd to 36th place in the Dealing with Construction Permits sub-index of the World Bank’s ease of doing business ranking.

Also, the quality of telecommunications has advanced immeasurably in recent years, making life for businesses much easier than before and enhancing their ability to compete internationally. Other things have improved in individual countries: for example, Montenegro has made important changes to tax administration in recent years, and this has clearly been welcomed by businesses which see the issue as being much less problematic than previously. Serbia has also improved the ease of paying taxes for companies by introducing an online system for filing and paying VAT and social security contributions in 2014.

The cost of different obstacles varies in line with different firm characteristics. Innovative firms, for example, find corruption more costly than companies that do not innovate, and they are also more affected by an inadequately educated labour force. Manufacturing firms are more worried about lack of access to finance than service companies. And firms competing on international markets are especially concerned about customs and trade regulations. So what does all this mean for policy-makers?

First, governments should prioritise reforms, based on a clear strategy of development with long-term goals. If the survey, for example, reveals a clear skills mismatch, then this requires a long-term plan to improve standards and train young people for a modern economy rather than equipping them with obsolete skills. Second, countries in the region should learn from the experience of others, including former socialist countries now in the European Union that faced the same problems, and copy best practice in tackling business environment obstacles. And third, the region needs to market better its advantages to potential foreign investors. EU proximity, macroeconomic stability, favourable labour costs and diverse economies are just some of attractions that should be highlighted by all Western Balkans countries.

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