Geopolitics overshadows Western Balkan nearshoring ambitions

Geopolitics overshadows Western Balkan nearshoring ambitions
North Macedonia, a recent Nato entrant and longstanding EU accession candidate, has seen a hike in foreign investment.
By Clare Nuttall in Glasgow February 1, 2023

During the pandemic the Western Balkans was pegged as having the potential to become an important destination for nearshoring as people rethought and shortened their supply chains. Two years on, the war in Ukraine and not the pandemic dominates headlines and has caused a whole new set of disruptions to global trade as well as a global economic downturn. 

So where does this leave the Western Balkan states longing for a boost to foreign direct investment (FDI)? The region’s economies, like others in Europe and worldwide, have been damaged by the war, sanctions and rampant inflation. Yet data so far shows there was an increase in investment in the region in 2022 — with the glaring exception of Serbia, which has refused to join international sanctions on Russia, with negative consequences for its reputation in the West and its EU accession prospects.

Nearshoring dreams 

After the pandemic revealed the vulnerability of international supply chains, companies in Europe started rethinking their strategies to look at manufacturing destinations closer to home, rather than relying on far-flung suppliers in East Asia. With the start of the pandemic, links in international supply chains were abruptly severed, and this followed on from the protectionist policies in some key world economies in the years before the pandemic that appeared to signal a slowdown or even a reversal in the long-standing globalisation trend. 

This was seen as creating opportunities for the Western Balkans: the six EU-aspiring states are geographically and culturally close to the Central and West European countries but with considerably lower costs, as pointed out in two separate studies from 2021. (Both studies did, however, stress that to attract potentially billions of euros in FDI, the Western Balkans needs to make reforms.) 

This was a welcome development for the region, where countries such as Bosnia & Herzegovina, North Macedonia and Serbia in particular had received a series of investments in sectors such as textiles and car parts production, strongly encouraged with subsidies and other incentives. 

A year and a half later, full data from 2022 isn’t available yet, but data for the first three quarters of the year from most countries indicates a rebound in investment. Branimir Jovanovic, economist at the Vienna Institute for International Economic Studies (wiiw), says that the data gives “very strong indications that some nearshoring is going on in the region”. 

North Macedonia, for instance, saw investments double in the first three quarters of 2022 compared to the same period in 2021, while in several other countries it has risen by around 30-50%. That comes on top of the very strong inflows in 2021.

Jovanovic does, however, say it’s rather early to say to what extent this is nearshoring or just pent-up investment from the pandemic years. After barely three years since the pandemic began, companies have had little time to make and carry out investment decisions. And as he points out, companies are more likely to enter the region for greenfield investments rather than relocate existing production facilities. 

“We won’t see many companies moving factories because it’s costly; they have fixed investments, sunk costs,” comments Jovanovic. “We do expect to see in future Western companies deciding to invest more in the Western Balkans, North Africa and Eastern Europe, rather than in East Asia.”

Yesterday's buzzword 

Despite these encouraging figures, the invasion of Ukraine shifted the emphasis from investing in nearby countries to investing into friendly countries with shared values. “Nearshoring is the story of the past. Friendshoring is the new trend,” says Jovanovic.

The Ukraine war has not only had a massive impact on international trade and investment, with the related sanctions, commodity shortages and inflation now causing economies to slow, but also on international geopolitics. 

Natalia Otel Belan, regional director for Europe and Eurasia at the Center for International Private Enterprise (CIPE), says investment destinations are now viewed in the context of the "global fight between autocracy and democracy”. 

“If we look back to when we were coming out of the pandemic, before the war in Ukraine, there was a lot of optimism globally, including in the Western Balkans, that economies were coming back to normal speed and there would be a pick-up in economic growth. But the war in Ukraine changed everything. It’s made everybody’s calculations for politics, economics and trade completely different,” says Belan. 

She believes that going forward, the Western Balkan region risks being sidelined as Ukraine has become the top priority for the West, with the “attention of EU policymakers and investors away from the Western Balkans”.

“Priorities have absolutely changed. It’s now all about Ukraine, so it is much harder for this region to make a case for why the Western Balkans matters,” she says. 

This is despite an awareness among EU policymakers that if they don’t pay enough attention to the Western Balkans, the region could “fall prey to malign forces Russia continues to meddle all around through its proxies,” says Belan.

A rare positive from the war has been the increased awareness of the importance of European integration, which led to the long-awaited start of accession negotiations with Albania and North Macedonia, and candidate status for Bosnia, Moldova and Ukraine. 

Serbia the loser

Serbia has been the clear loser from this new way of thinking. Belgrade has long been criticised by frustrated Western politicians for “sitting on two chairs”, a commonly cited proverb. In fact it has been four chairs or rather four pillars, according to the official line from Belgrade, which for a long time successfully balanced relations with the EU, the US, Russia and China. That stood it in good stead, as it was able to attract investment (and during the pandemic vaccines) from multiple sources, but it collapsed when Russia’s invasion of Ukraine suddenly polarised the world and made sitting on two chairs untenable, despite the government’s best efforts. 

While almost all of the region is expected to receive much stronger FDI inflows in 2022, Serbia is the exception, as in nominal terms it saw a stagnation (for the data available so far), and FDI declined as a share of GDP. This is a big change, as Jovanovic notes that until now, “Serbia was considered to be the success story for FDI in the region”. 

Specifically, investment from EU countries dropped sharply in 2022, accounting from only around one-third of the total compared with around 60% in previous years. By contrast, Chinese FDI increased a lot, and in 2022 China will be the biggest investor, overtaking the EU for the first time. According to wiiw, data from the first three quarters show Chinese FDI at around €1bn, or 36% of the total, while from EU countries it is around €900mn, or 32%. 

“For the same reasons as some companies left Russia, they are not investing in Serbia now. They don’t consider Serbia to be friendly to the West, to the EU. And because of that they are saying we don’t want to invest in this country which is a friend of Russia,” says Jovanovic. 

He cites company executives from Germany and other countries who disclosed they are having second thoughts about investing in Serbia because of the political uncertainty. “So far, they are postponing decisions to invest in Serbia, but if things do not improve they might also cancel investments. It seems Serbia is [paying the] price for its uncertain position re the Russia and Ukraine war.” 

The winners 

By contrast to Serbia, 2022 was a very good year for North Macedonia, and to some extent for Bosnia too. Both countries have attracted large amounts of investments into manufacturing over the years, while Montenegro, and to some extent Albania, has seen more investment into tourism and real estate. 

North Macedonia has been a strong performer for years; even during the political turmoil towards the end of former prime minister Nikola Gruevski’s rule it consistently performed well on the World Bank’s annual Doing Business ranking. Now investments into manufacturing are growing strongly, especially in the automotive sector. 

While Serbia has suffered for its politics, the opposite appears to be true of North Macedonia. Jovanovic says he believes the resolution of the name dispute and North Macedonia’s entry to Nato have paid a dividend. 

Bosnia suffers from endemic political turmoil but that conceals an economy that is quietly growing, with the benefits of a relatively skilled workforce and transport links to neighbouring EU member Croatia.

Another positive development in the region has been the gradual increase into investments into higher value activities. This looks like the start of the trend long seen in Central Europe now a major destination for the electric vehicle (EV) industry and other higher value sectors. 

Undoubtedly, the Western Balkans’ large pool of cheap labour remains a selling point. With a population of around 20mn people, Jovanovic estimates there are up to 1mn people unemployed. “In terms of numbers, [I] think they have capacity at last for attracting companies for another decade or so,” he says. 

While output per worker remains lower than in the EU, the region retains some of the legacy of the socialist era, when the region had a highly skilled workforce some employers from Germany still arrive with a positive image of Yugoslav workers from the Gastarbeiter era. 

Still, there is a strong need for investment into the region’s labour force, along with infrastructure, which also still lags behind the EU countries in the region. 

When the war ends

When the war eventually ends, there will be a massive reconstruction effort in nearby Ukraine. Figures already being estimated for the cost of rebuilding the damage done by almost a year of fighting are in the range of $500bn-$750bn. 

Belan believes it will be more difficult for the Western Balkans to attract nearshoring investments when attention turns to post-war Ukraine, with its much larger economy and inflows of billions in reconstruction funds. 

“The selling point of region before war to investors was to focus on labour costs, cost savings … now it will be much harder for the Western Balkans to make that pitch. They need to focus on new competitive factors: not only on labour costs and short distances, they need to think about the quality of the labour and better infrastructure,” she argues. “Ukraine is a bigger market, and the Western Balkans is still small and fragmented.”

She argues that rather than competing with post-war Ukraine for investment, the Western Balkan countries “need to gear themselves to what Ukraine might need for reconstruction”. 

Another factor that will make the region of small and fragmented economies more attractive is regional integration.

“First and foremost, the region needs a harmonisation of the markets, of the business climate, rules and regulations … so they do not see each other as competitors but as complementary, and work together to scale up production, access to resources, innovations, technology and infrastructure,” Belan says. 

However, this is not easy, as the experiences of the last 20 years have shown. Initiatives like Open Balkan, set up to create common market for goods and labour in the region, target this goal, but typically become bogged down in the divisions between the countries in the region; so far Open Balkan’s three founders have failed to persuade the other three countries to join. 

The Western Balkans has advantages that it is using to attract growing amounts of investment, but it also has many legacies of the past to overcome.