Western Balkans: Too small to be the next big thing?

Western Balkans: Too small to be the next big thing?
Southeastern Europe could be the next region to boom if industry moves in
By Clare Nuttall in Glasgow April 5, 2019

Central Europe has been enjoying a boom for the last few years driven by investment into export-oriented sectors. The region’s relatively low costs, high skills base and its proximity to Germany and other West European markets make it a highly attractive investment destination, especially for big carmakers and components manufacturing. But the fast pace of growth cannot continue. Countries in the region are starting to experience serious labour shortages. The boom has passed its peak and all the economies of the region are going to have to reinvent themselves once again.

A raft of statistics recently released in the region already shows the pinch setting in. Unemployment in the Visegrad countries has plummeted to levels not seen since immediately after the collapse of communism nearly three decades ago. Wages are rising to record levels. And the slowdown isn’t limited to Central Europe; Southeast Europe’s largest economy Romania had the fastest growing labour costs in the EU in 4Q18, and there are reports of a tightening labour market in fellow EU member Bulgaria.

The magic recipe of low costs and high productivity is wearing off as the Central European economies emerge leading investors to start to look past Central Europe in the never-ending quest to find new, cheaper destinations. Cheap labour flooding in from a collapsed Ukrainian economy has brought some temporary relief – a fifth of Ukraine’s workforce is now overseas in the EU looking for work, 2mn of which are in Poland alone – but this won’t last forever.

The obvious place to go is to fan out southeast towards Romania and Bulgaria, then perhaps further afield to the Western Balkans countries, all of which are aspiring EU members. Arguably, the prospect of EU accession is the single most important factor driving reforms in the former communist countries. Certainly the only strategy that has been a stand-out success for the former socialist block countries has been a very simple one: join the EU. States have to demonstrate sufficient reforms and democratisation to secure candidate status, then go through the lengthy accession negotiation process that comprises dozens of chapters on areas from movement of goods and labour, to agricultural policy to the judiciary. The pay off is off-the-shelf functioning institutions, huge grants for infrastructure investment and unfettered access to one of the largest and richest markets on the planet.

This isn’t to say EU accession is a panacea to all the problems faced by the post-communist economies. “There wasn’t a transformational moment when the first wave countries from CEE joined the EU. There were a lot of problems that didn’t disappear on accession — corruption, rule of law and so on,” says Cvete Koneska, associate director at specialist global risk consultancy Control Risks, in an interview with bne IntelliNews. However, she adds, “I still think that if a West European investor looks at two markets where all else is equal and one is an EU member state, they probably would choose the member state.”

The long road to accession

The violent breakup of Yugoslavia caused the fortunes of its successor states to diverge dramatically. While Slovenia was among the first wave of entrants to the EU from the former eastern bloc countries, it took the best part of another decade for Croatia to join – and the remaining countries from the region are still chasing membership.

Serbia and Montenegro are the closest, having opened negotiations several years ago, and the tentative accession target date of 2025 was set out in the European Commission’s new strategy published in 2018 with the aim of revitalising the enlargement process. Previously, enlargement had slowed after Croatia’s entry in 2013, and observers noted worrying backsliding in democratisation in the region and the emergence of increasingly authoritarian local leaders as hopes of accession faded. Despite being preoccupied first by the migration crisis and more recently Brexit, EU officials are now devoting more attention to the Western Balkans countries. For some countries, especially those early in the process, more may be needed.

“In general the EU is an important institutional anchor for the Western Balkans, but only as long as the likelihood of accession is still there. Probably at the moment people have the feeling that not a lot of changes are being made, and the EU certainly could support the efforts of those countries to take over the acquis communautaire by increasing support for investment, for example in infrastructure and state capacities,” said Richard Grieveson, economist at the Vienna Institute for International Economic Studies (wiiw), in a webinar on March 27.

Many complex issues still need to be resolved even among those states closest to accession. Serbia’s unresolved conflict with Kosovo is stalling its progress, while Montenegro is struggling with corruption and organised crime. Among the other would-be EU members from the region, both Albania and Macedonia are candidates and hope to get the nod for accession negotiations to start this summer. Bosnia hopes to get candidate status soon, but political infighting and a gapping power vacuum that appeared following the October 2018 general election are holding it back. Kosovo is the furthest off from obtaining candidate status, as five EU members do not recognise it as an independent state.

Even with EU accession as a far off prospect, there have been a significant number of investments into the Western Balkans by international manufacturers, even though volumes are for the most part small compared to those in CEE. Italian carmaker Fiat usually takes the top spot among Serbian exporters, and is a longstanding investor in the country, while in recent months new factories were opened in Serbia by the US’s Amphenol Automotive Technologies, fellow auto-components producer from the UK Delphi, and Calzedonia, an Italian producer of socks, bathing suits and underwear. Announcements of new investments were also made by Chinese car-parts producer Minth, German automotive cable manufacturer Leoni and — from Serbia’s near neighbourhood — Slovenian household appliance Gorenje has shifted some of its production to Serbia.

North Macedonia (formerly Macedonia) aggressively pursued export-oriented foreign direct investment (FDI) for years under the previous government that was in power from 2006 to 2016. It’s too early to say what the change of government in 2017 will mean for investment, but there have been several recent announcements of fresh investment, including from Germany’s Gerreshimer, which supplies the pharma and healthcare industries, fellow German investor ODW Elektrik, and the US’s Dura Automotive Systems. As the political situation stabilised after a lengthy crisis from 2015 to 2017, exports from Macedonian free industrial zones revived, jumping by 20% in 2018 alone.

Serbia, meanwhile, came out on top of IBM’s 2018 Global Location Trends report based the number of job created in a country by FDI, relative to the size of the country’s population, and Bosnia and North Macedonia were also among the top ranked countries, although jobs created per million inhabitants dropped in North Macedonia in the crisis year of 2017 compared to 2012-2016. Serbia “continues to receive significant inward investment in key sectors such as textiles, transport equipment, chemicals and electronics. Not surprisingly, manufacturing activities account for almost 80% of jobs created from FDI,” the report said.

“The continued strong performance by Serbia and the wider Western Balkans on this measure testifies to the region’s growing success in attracting foreign investment and cementing its position in global value chains. While the performance of individual countries varies from year to year, the region as a whole is experiencing a sustained high level of interest from foreign investors,” according to IBM’s study.

That’s looking at job creation, an urgent priority for governments in a region beset by high unemployment. But in terms of the size of investment, FDI remains low. An earlier report from the United Nations Conference on Trade and Development (UNCTAD) found that only Albania and Serbia reported a significant increase in FDI above 2010 levels in 2016, while overall, “inflows to the region have partially recovered from the post-crisis low of $3.8bn in 2012, but they reman far from the peak of $8.7bn in 2008.”

The organisation does, however, point to “significant potential” for manufacturing in the region “With its competitive labour costs and proximity to European and emerging markets in Asia and North Africa, the region is strategically placed to attract efficiency-seeking FDI in the manufacturing export sectors and their value chains,” says the report. “This includes the automotive sector, in which cars have been produced since the 1950s.”

A question of stability

While cars (and a plethora of other items) have been produced in the region for decades, the economy of ex-Yugoslavia was violently torn apart amid the wars of the 1990s. This meant the newly independent states started their transitions much later and from a much worse starting point than their counterparts in CEE. In Albania, which already lagged behind the rest of the region following the collapse of communism, there was also a turbulent early transition period and the country was plunged into violence after the collapse of pyramid schemes in 1997, only narrowly avoiding a civil war.

The economies of the Western Balkans therefore have a long way to go before they can catch up with the rest of Central and Southeast Europe — a 2019 report from the European Bank for Reconstruction and Development (EBRD) says it could take up the Balkans a staggering 180 years to catch up with Central Europe — but there is also a need to catch up politically as well. With some exceptions, the Western Balkans countries perform worse than their counterparts from the EU on measures such as Freedom House’s Nations in Transit report, which assesses democratic governance in 29 post-communist states. On the latest report in 2018, Montenegro and Serbia were classed as Semi-Consolidated Democracies, on a par with Romania and Bulgaria but behind Slovenia and most CEE states that were rated as Consolidated Democracies. Meanwhile, the other Western Balkans countries were put in the Transitional Government or Hybrid Regime category. Most states from the region are ranked lower on Transparency International’s annual Corruption Perceptions Index than their northern neighbours.

In the last few months, mass protests that in some cases have ended in violent clashes with police have erupted in Albania, Montenegro and particularly Serbia, where weekly demonstrations have been ongoing for months. Waves of mass protests aren’t uncommon in the region, where opposition groups often take courage and inspiration from demonstrators in neighbouring countries. However, the latest protests have shown more staying power than most and in Serbia, for example, have brought together a broad spectrum of opponents to President Aleksandar Vucic’s rule, from liberal intellectuals to far-right nationalists.

Vucic has so far said he will not give in to demands from the street, and while he has said early elections are planned, the likely objective is to reinforce the legitimacy of his government in the eyes of the Serbian population and international observers with an election win. However, the persistence of the protests has started to raise the question of whether Serbia could follow Macedonia to the eventual removal of its long-time leader.

“The developments are starting to look like those in Macedonia, which eventually led to a change of government,” commented Vladimir Gligorov, senior research associate at wiiw, in a recent comment on the Serbian protests. However, there are certain differences: “The weakness of the opposition parties is why the Serbian legitimacy crisis is only in its early stages. On the one hand, they have next to nothing to offer to achieve external legitimacy, in stark contrast to the Macedonian case, while they hope to come to power on the back of the civic uprising that they cannot offer leadership to,” wrote Gligorov. 

The protests by themselves, even when they result in small-scale violence, are not a cause for concern for investors, and protesters have not targeted the assets of international companies. But what they might eventually lead to is.

“Political stability is always on top of the list for investors when they look at possible risks. In Serbia, for example, they are not worried about direct attacks on business assets, but over instability and policy effects such events as a change of government could have,” says Koneska. “Often in this part of Europe a change of government means a significant reversal of laws including those that affect business, such as tax policies and incentives. The investment cycle for some sectors, such as energy, mining and renewables, is much longer than a government’s term in office so investors in these sectors look for longer-term stability. The other key type of risk concerns corruption and the rule of law. Often domestic businesses linked to politicians have an unfair advantage, the playing field is not even and it’s not obvious where the pitfalls are.”

Too small to compete

Aside from the recent run of protests, the countries of the Western Balkans have structural problems that could rule them out from being credible alternatives to Central Europe at least for the foreseeable future. The biggest problem is their small size.

The most populous country in the region, Serbia, has only 7mn inhabitants; Montenegro has a population of just over 620,000. This means they are unable to offer the scale of labour pool to attract investors in large numbers. And this is unlikely to change as the Western Balkans for the most part suffers from the same low birth rates and high emigration as the CEE countries. From this point of view there would be a better case to enter Ukraine, with its 44mn-strong population, but the politics are so unstable that rather than FDI flowing into Ukraine, millions of Ukrainians have been flowing out to look for work, taking up vacant positions in Poland and other Central European countries,

Secondly, these are not just small but also highly fragmented markets. Supply chains that once spanned Yugoslavia were severed with the breakup of the federation in the 1990s. Infrastructure, if not destroyed in the wars, no longer made sense when borders were redrawn, and deteriorated. Despite ongoing investments into roads and railways in the region, most financed by either EU infrastructure funds or Chinese loans, the transportation links are far worse than those in Central Europe.

Then there are the administrative barriers, again unlike in CEE, where countries have been part of the EU common market for 15 years now. Serbia’s Vucic has been pushing a proposal to create a Western Balkans common market by removing barriers to cross-border trade within the region, which as well as benefitting local exporters and importers would encourage FDI — Vucic claimed in 2018 this would double the current level of FDI and bring in at least $8bn-9bn of investments a year. However, while the concept has support from some top EU officials, there is less enthusiasm within the region.

“There has been a lot of talk about a common market for the Western Balkans, but little action,” Koneska tells bne IntelliNews. “Politicians see little benefit or political capital from the idea, which is often described as a ‘mini Yugoslavia’. What they are trying to achieve is to join the big EU market, not to create a free market for the region, so it’s not seen as a priority among governments in the region.”

It’s also at the mercy of complex regional politics, and looks like an even further off prospect since Kosovo slapped 100% import tariffs on goods from Serbia and Bosnia in a politically motivated move in late 2018. Despite external pressure, the tariffs remain in place with a damaging impact on trade.

Migrate or automate

But probably the biggest problem for the Western Balkans countries when it comes to attracting inward investment, is that there isn’t a solid case to claim the region is better value than CEE when productivity is taken into account.

A report released by the World Bank and wiiw in March points out that while wages and labour costs are significantly lower in the Western Balkans than in the EU — with no clear convergence in recent years — “When compared to productivity, the apparent labour cost advantage of the Western Balkans countries disappears and the two most direct EU competitors, Bulgaria and Romania, seem significantly more competitive.”

This means that while there are success stories from the region — notably Fiat in Serbia — the Western Balkans can’t be viewed as a viable alternative to Central Europe in the near future. The answer to this problem is to invest into its people, but this is a very long-term project. There is also the chance to invest into infrastructure and technologies that could allow them to catch up faster, following in the footsteps of other tiny countries that have become champions in specific areas such as Estonia (population 1.3mn) in the digital economy or Slovakia (population 2mn) in automation.

But in the meantime, companies are starting to respond to the CEE labour squeeze by investing into automation. How successful they are will likely determine whether CEE becomes a higher value location, or if companies choose to look east for lower costs.

“The big companies, mostly controlled from Germany or Austria, have a decision to make,” said Grieveson in the wiiw webinar. “They can go further east or further south where there is more labour, but I think countries in [Central Europe], especially the Visegrad countries and Slovenia, have big advantages — proximity to western markets, infrastructure, and even though these may be deteriorating, better institutions. Our sense is that foreign companies will mostly stay in the region and automate, but there’s definitely a risk that they don’t.”

 

This article is the cover story to April issue of bne IntelliNews’s monthly flagship magazine.

Read the whole magazine here:

Subscribe (free) here:

Features

Dismiss