Vladimir Gligorov

Balkan geography of animosity and cooperation

Introduction
Balkan economies tend to grow strongly with increased security and political stability.
The resolution of Kosovo crisis in 1999, the democratization of Croatia in early and Serbia in late
2000, the resolution of the Macedonian crisis in 2001, and the independence of Montenegro in
2006 have all contributed positively to growth and development of the particular countries and of
the region as a whole. Similar positive effects should be expected with the resolution of the
Kosovo status and political stabilization of Serbia. With the improvement of security, economic
cooperation improves. Given this strong influence of security risks and political stability, it is
important to be clear about the geography of animosity and cooperation in the Balkans.
A distinction is drawn here between security and political risks as their political and
economic consequences are quite different. Former emanate from animosity or enmity while the
latter are the consequence of the characteristics of the constitutional set up or of the political
system. Security risks are about the probability of the use of violence to achieve political, social
or economic aims, while political risks are an indicator of the efficiency of public governance or
of the political process. The lower the risks the better are prospects for cooperation both within
and between countries. The opposite is also true: increased cooperation tends to decrease security
and political risks albeit only up to the point. This is also true of regional cooperation, which also
in the Balkans depends very much on cooperation with the European Union.

Conflicts and Risks

The geography of animosity in the Balkans is about the areas where there are significant
security risks, both between states and within states. When it comes to the international security
risks, there is only one deep animosity left, that between Kosovo and Serbia. This is because they
are conflicting over territory. There is also only one significant internal, civil animosity left, the
one within Serbia. As the world has been reminded recently, after Kosovo declaring
independence in February 2008, civil strife within Serbia and violent conflicts in the northern part
of Kosovo are still possible. It is probably only the international presence, military and civilian,
in Kosovo that is standing in the way of a violent confrontation within Kosovo and between
1
Kosovo and Serbia. However, the international presence does not provide for internal stability of
Serbia itself, where political confrontation between the “patriots” and the “traitors” is heating up
and is probably going to be responsible for continuing political instability and non-negligible
possibility of civil strife.
Political risks, unlike security risks, are much more geographically spread. Political
instability is fuelled by constitutional problems (Bosnia and Herzegovina), slow democratization
(Bosnia and Herzegovina, Macedonia, Serbia and Montenegro), and social dissatisfaction that
supports populist parties, which combine ethnic and economic nationalism with social
demagoguery. Still, these political conflicts are resolvable without recourse to violence, though
they are not without social and economic consequences. In general, it can be argued that political
risks are increasingly an issue of the success of the process of democratization and of the building
of the rule of law.
This political instability, for whatever reason, influences economic policies that worsen
macroeconomic imbalances, both internal, i.e., in the labor market as low employment and high
unemployment persist (the unemployment rates range between 20 and 40%, Croatia being an
exception with just over 10%), and external, that is in the trade (above 20% of GDP as a rule) and
current account balances (close to 10% or more of GDP, Macedonia being an exception with
close to balance). These imbalances are not necessarily unsustainable as long as high growth,
now averaging between 5 and 6 per cent per year, continues. If growth slows down, because of
growing security risks or greater political or social instability, Balkan economies would face
serious challenges.

Trade and Investment in the Balkans: Stylized Facts

The story of transition has been one of growing trade and investments. Research on trade
in the Balkans indicates that these economies are different because they tend to export much less
than, for instance, transition countries in Central Europe. Indeed, some of these economies are
surprisingly closed if export to GDP is the criterion of openness. That indicates that their actual
exports are way below their potential (Christie 2004). In addition, their exports tend to be quite
concentrated into just few goods and services. Thus, these countries resemble developing
economies at least when it comes to their structure of exports (Gligorov 2007).
Research on investment leads to similar conclusions: investment levels are lower than for
instance those in Central Europe and they tend to go into services and sectors that depend on
2
domestic demand. In addition, remittances play a crucial role in supporting the balance of
payments. Finally, credits are growing and are mostly used to finance consumption.
These stylized facts are changing slowly in a number of countries. In the last few years
exports have been growing rather fast due to favorable prices of some of the exporting
commodities, but also due to improved access to markets. There are some examples of
investments in industries oriented towards exports. As a consequence, the sustainability of trade
and current account deficits has improved in a number of cases. These are developments that
resemble those in Central Europe about ten years ago. However, there is some way to go in terms
of policies and in terms of structural change.

Trade and Investment in Macro and Micro

The macro picture of foreign trade in the Balkans is not very encouraging. In Figure 1
trade deficits of the countries in the Western Balkans can be found. It is clear that those are high
and are not showing decisive signs of changing for the better. In a number of countries, e.g., in
Serbia and Croatia, exports cover imports by 50% or less. In other countries, the coverage is even
lower.
Figure 1
Trade deficit, 2000-2006
in % of GDP
2000 2001 2002 2003 2004 2005 2006
0

-10

-20

-30

-40

-50

-60
HR MK AL BA ME RS

Source: wiiw incorporating national statistics.

Current account deficits are smaller, as a rule. Still, as can be seen in Figure 2, those are
quite large. They have also mostly tended to increase – Macedonia being one important exception
in recent years. Improvements, where they happen, are mostly due to growing inflows of
remittances, except perhaps in Bosnia and Herzegovina where exports have increased remarkably
in the last couple of years, albeit from a rather low level. Some deterioration is due to growing

3
investments, which is the case of Montenegro. Similarly, growing current account deficits in
Romania and Bulgaria are to a large extent due to growing investments, both direct and debt
creating. In a number of cases, however, worsening current account deficits are due to fast grows
of imports that at least in part reflect worsening terms of trade and competitiveness indicators. In
some cases, current account deficits are worsening because of widening deficits in the services
balance and in the income balance. The latter is the consequence of the growing stock of foreign
investments and foreign obligations in general.
Figure 2
Current account, 2000-2006
in % of GDP
2000 2001 2002 2003 2004 2005 2006
0

-5

-10

-15

-20

-25
HR MK AL BA ME RS

Source: wiiw incorporating national statistics.

Still, growth of exports has been a feature of Balkan development, as Figures 3 and 4
indicate, especially after the year 2000. Clearly, the dynamics is not the same as in NMS, but in
the recent years the speed up of growth of exports is quite visible. In some countries, e.g. in
Serbia, growth has been quite fast, though the overall level of exports is still rather low.
Similarly, exports are growing in Bulgaria and Romania, but also in Bosnia and Herzegovina and
in Macedonia. Figure 4 suggests that this speed up of exports is sustainable and that suggests that
the experience of the Central European countries in transition may indeed be repeated in the
Balkans too. It is clear, however, that some of the laggards are to be found among the Western
Balkan countries. Croatia does not seem to be all that export oriented, at least when it comes to
exports of goods. Generally it has to be recognized that the Balkans have comparative advantages
in tourism and some of the countries in that region may tend to resemble Greece even after they
become much more developed than they are currently.

4
Figure 3
Exports in NMS and SEE, 1990-2006
1990=100

BG HR MK RO CS NMS-5
1000
900
800
700
600
500
400
300
200
100
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Legend: NMS-5: CZ, HU, PL, SK, SI.

Source: wiiw incorporating national statistics.

Figure 4
Exports in NMS and SEE, 2000-2006
2000=100

BG HR MK RO RS ME AL BA NMS-5
350

300

250

200

150

100

50
2000 2001 2002 2003 2004 2005 2006

Legend: NMS-5: CZ, HU, PL, SK, SI.

Source: wiiw incorporating national statistics.

Growth of investments can be seen in Figures 5 and 6. The development compares Balkan
economies with the new member state (NMS) in Central Europe. Clearly, Balkan countries have
started to receive foreign investments later than the NMS and have yet to record similar levels of
inflows. Notable exception is Croatia that has quite significant level of foreign investments in per
capita terms. In all other countries, investments are growing fast in the last couple of years,
though in some, like Serbia, the amounts are volatile and reflect the changes in the speed of
privatization and the macroeconomic risks. The structure of investments as seen in Table 1
indicates preference for manufacturing, but also for trade and other services especially tourism in
the case of Croatia and Montenegro.
5
Figure 5

FDI stock, per capita, in NMS and SEEC,

1998-2006, EUR

NMS-5 BG RO SEEC-6
4000

3000

2000

1000

0
1998 1999 2000 2001 2002 2003 2004 2005 2006

Legend: NMS-5: CZ, HU, PL, SK, SI; SEEC-6:HR, MK, RS, ME AL, BA
Source: wiiw incorporating national statistics.

Figure 6

FDI stock, per capita, in NMS and SEEC,

1998-2006, EUR

NMS-5 BG RO
5000

4000

3000

2000

1000

0
1998 1999 2000 2001 2002 2003 2004 2005 2006

AL BA HR MK ME RS
5000

4000

3000

2000

1000

0
1998 1999 2000 2001 2002 2003 2004 2005 2006

Legend: NMS-5: CZ, HU, PL, SK, SI;

Source: wiiw incorporating national statistics.

6
 Table 1

Inward FDI stock in SEE-4 by economic activities

as of December 2005, share in per cent

AL BA HR MK SEE-4 BG RO

A_B Agriculture, hunting, forestry, fishing 0,5 . 0,3 1,3 0,4 0,7 0,6
C Mining and quarrying 1,2 . 3,3 2,2 2,6 0,9 7,3
D Manufacturing 36,3 41,2 33,4 43,8 36,0 12,8 37,3
E Electricity, gas and water supply 0,2 . 0,8 0,4 0,6 0,2 4,2
F Construction 5,6 . 0,6 3,5 0,9 3,8 0,8
G Wholesale, retail trade, repair of veh.etc. 9,6 9,4 9,5 6,7 9,1 10,3 15,0
H Hotels and restaurants 3,0 1,5 6,6 1,6 5,1 1,1 0,2
I Transport, storage and communication 36,9 0,5 15,7 24,1 14,8 23,4 12,3
J Financial intermediation 2,4 39,8 26,3 13,2 26,3 34,9 14,5
K Real estate, renting & business activities 3,3 . 2,6 2,3 2,2 9,6 7,7
L Public administr., defence, comp.soc.sec. . . 0,1 . 0,1 . .
M Education 0,1 . 0,0 . 0,0 . .
N Health and social work 0,1 . . . 0,0 0,0 .
O Other community, social & pers.services 0,9 . 0,7 . 0,5 0,7 .
Other not elsewhere classified activities 0,1 7,6 . 1,1 1,3 1,5 0,2
. .
Total by activities 100,0 100,0 100,0 100,0 100,0 100,0 100,0

Total by activities, EUR mn 298 2253 9921 1769 14241 9674 21885

AL: Albania, BA: Bosnia and Herzegovina, HR: Croatia, MK: Macedonia, SEE: Southeast Europe.

The micro structure does show that Balkan trade is different from that in NMS. Figures 7 to
9 tell the story. Clearly, Balkan countries sell to the EU mostly goods with low technological content
or products that are not driven by technology. There is also little improvement to be detected in the
last five or six years. Similarly, labour intensive industries export more than those that are capital
intensive (Serbia seems to be one exception). Finally, exports from low-skilled industries take the
predominant share in Balkan exports to the EU. This is strikingly different from the trade structure of
the NMS. Also, improvements can be detected in the NMS, while they do not seem to be present in
the export structure of the Balkan economies.
Some research indicates that changes can be observed once real micro data is looked into
(Damjan et al 2006). It seems that firms that attract foreign investments tend to be more
technologically advanced and that they also have significantly higher labour productivity. Finally,
skill structure of such firms improves. It is than the problem that foreign investments are still not
playing the decisive role in the exporting sectors in these countries.

7
 Other research points to the fact that it is precisely the low skilled, labour intensive industries
that are losing out in transition and in international competition in general. Balkans still exports a lot
of textiles and apparel and those industries do not have much of a future. In general, labour intensive,
low skilled industries cannot be competitive even in the medium run due to the relatively high price
level in this region.
In some countries, agriculture provides significant exports. This is certainly true of Serbia,
but may prove to be the case in other countries too. Unfortunately, agriculture tends to be rather
unreformed and thus not very productive. This could change in the future, though the prospect of
agriculture being the driving force for exports from the Balkans is not a very realistic one.
Figure 7
Technology-driven industries,
as % of total manufacturing exports to the EU

2000 2001 2002 2003 2004 2005 2006

40
35
30
25
20
15
10
5
0
AL BA BG HR MK RO CS NMS-5

Legend: NMS-5: CZ, HU, PL, SK, SI.

Source: wiiw incorporating national statistics.

Figure 8
Labour-intensive industries
as % of total manufacturing exports to the EU

2000 2001 2002 2003 2004 2005 2006

60

50

40

30

20

10

0
AL BA BG HR MK RO CS NMS-5

Legend: NMS-5: CZ, HU, PL, SK, SI.

Source: wiiw incorporating national statistics.

8
Figure 9
Low-skill industries
as % of total manufacturing exports to the EU

2000 2001 2002 2003 2004 2005 2006

100
90
80
70
60
50
40
30
20
10
0
AL BA BG HR MK RO CS NMS-5

Legend: NMS-5: CZ, HU, PL, SK, SI.

Source: wiiw incorporating national statistics.

Regional Aspect of Comparative Advantages

The theory of comparative advantages has to be seen within the framework of trade policy
and especially bilateral, regional, and multilateral trade agreements. Most of the Balkan countries
are members of the World Trade Organization (WTO), but not all. Serbia, Montenegro and
Bosnia and Herzegovina are still negotiating with it. The region is benefiting from a preferential
treatment by the EU and faces zero tariffs for almost all exports. There are some quota
restrictions, but most of the quotas are generous enough so that those are not even filled most of
the time. There are other non-tariff barriers that may be more important, but it is not clear to what
extent. Most of the countries have contractual agreements with the EU, except for Serbia and
Bosnia and Herzegovina. The latter two are facing political conditions to signing the Stabilization
and Association Agreements. The negative consequence of that is that they can still hold on to
higher tariff protection and thus not benefit from competitive pressures. That does have negative
consequences for the efficiency of resource allocation, though it is not clear to what extent.
The countries in the Western Balkans have liberalized intra-regional trade and are now
members of CEFTA, a multilateral free-trade agreement fashioned after the old CEFTA, the
Central European Free Trade Agreement. The effects of the regional trade liberalization have
been positive, though not necessarily all that large. One expected consequence is that regional
partners will reveal different regional comparative advantages than those they are enjoying with
the EU or the other trading partners. The data on the structure of trade with different partners

9
does seem to suggest that some such effects can be detected. The story is illustrated in the Figures
10 to 11.

Figure 16:

Revealed Comparative Advantage in SEE, 2005, top 5 sectors (manufacturing by skills)

5 High skill industries

4 Medium skill/white collar

3 Medium skill/blue collar

2 Low skill industries

1 Electricity

Mining
0
AL BA BG HR MK MD RO CS
Agriculture/Forestry/Fishi
Top 5 RCA 2005 ng

Figure 17:

Revealed Comparative Advantage in SEE, recent increases, top 5 sectors (man. by skills)

5 High skill industries

4 Medium skill/white collar

3 Medium skill/blue collar

2 Low skill industries

1 Electricity

Mining
0
AL BA BG HR MK MD RO CS
Agriculture/Forestry/Fishi
Top 5 RCA increase 2000/2001-2004/2005 ng

10
 Consistently with the previous figures, it appears that high and medium skill industries do
not fare all that well in accessing the EU markets. It seems that they do a better job in the case of
trade with Eastern European economies, but still better in the intra-regional trade. Thus, bilateral
free trade agreements and now the regional free trade agreement should prove beneficial for the
development of the higher skilled industries that are targeting regional markets.
The importance of these effects should not be exaggerated though. Regional free trade
agreement induces trade diversion that may be somewhat similar to a protective measure in trade
with the rest of the world (Gligorov 1996). If that is the case that may benefit the more
industrially advanced economies in the region, but not the others. Also, some inefficiency could
be expected. Finally, it has been found in some research that liberalization of trade through the
reduction of tariff and similar types of barriers tends to increase the reliance on non-tariff and
other types of barriers.
Other expected effects of regional liberalization have not been detected yet. It was
expected that foreign investors will consider the region as a whole when deciding where to locate
their operations. This was expected to significantly increase intra-regional and other foreign
investment. This has yet to materialize. The region is still facing significant political and non-
economic challenges so that it is quite hard for the investors to treat it as one market, large
roughly as that of Romania, in number of inhabitants.

The influence of Serbia

Given the geography of animosity, the key remaining source of instability is Serbia. If
Serbia failed to stabilize politically even after the May 11, 2008 election’s relative success of the
pro-EU democrats, its economy, which is already under serious pressure due to growing security
and political risks, would slow down significantly and could very well experience even a serious
recession. Serbia needs about 5 billion euro per year to finance its current account deficit (that is
based on the deficit in 2007), that is imports and thus consumption, until its economy recovers
and if foreign financing becomes unavailable or costly, consumption and investments would
suffer with growth disappearing or even turning negative. That would have significant
consequences for social stability, because of the already high rate of unemployment and general
feeling that the lot of the majority of the population has not been improving since the start of the
democratization and economic reforms in the year 2000.
11
 The consequences of Serbian political and economic instability would not necessarily be
dramatic for the Balkan region, especially if Serbia continues to support regional economic
cooperation as it has done even since the Kosovo declaration of Kosovo independence on
February 17 this year. There are indications that trade and other economic relations with Kosovo
have been affected negatively, but that hurts mostly Serbia itself and not very much anybody else.
However, if political animosities spill over into lack of regional cooperation, the negative effects
will certainly spread. To assess these effects, the geography of cooperation is important.

Cooperation and the EU

There are essentially two main trade routes within the Balkans. One is between Croatia
and Bosnia and Herzegovina and the other is that which centers on Serbia, which is serving as
hub for trade with Bosnia and Herzegovina, Macedonia, Montenegro and Kosovo. Other intra-
regional trade is small, except for that between Macedonia and Kosovo. If Greece, Austria and
Slovenia are added to the wider region, and more recently Hungary, then their trade with some of
the countries of the region has to be seen as important and their investments even more so.
Serbia is especially dependent on exports to the region and to investments from the wider
region. It stands to lose a lot if it curtails regional cooperation due to political animosities. For
this reason, there has been no attempt to withdraw from the region and this should not be
expected even if the process of European Union integration stalls due to the opposition in the
Serbian parliament which is still dominated by the nationalist parties. Of course, if economic
situation deteriorates, the region will lose an important economic partner and Serbia may decide
to introduce protectionist measures. In addition, if populist and bellicose parties were to gain
power in Serbia again, that would economically isolate Serbia and would make the whole region
less attractive for business and political cooperation.
While political instability in Serbia is having negative effects on that country and some of
its neighbors, the resolution of Kosovo status should in principle have a positive effect due to
increased investments there, but also because of the changed image of the region as a whole. So
far foreign investments have not materialized because the process has not been smooth and
stability is yet to be achieved. Also, there are still significant security risks in and around Kosovo.
Once this last remaining security risk is removed, overall regional risk will decline and Balkan
economies will benefit.

12
 The remaining causes of political instabilities as well as problems with economic
development can best be addressed through the process of integration into the NATO and the
European Union. This is clearly true for Bosnia and Herzegovina, though it has not received all
that much attention lately. It is especially in the case of this country that the distinction between
security and political risks can prove to be the most useful. Unlike the conflict between Serbia
and Kosovo, the constitutional problems within Bosnia and Herzegovina generate political, but
not serious security risks. Though commentators are often linking these two risky areas, the types
of risks they experience are quite different. And so are the solutions: in Bosnia and Herzegovina,
it is the process of constitution building, so the two state like entities there need to find a
constitutional framework that they could live with, while in the case of Serbia it is an issue of
control over territory, which is a different risk generator altogether.
Similarly, the problems within Macedonia and between Macedonia and Greece are those
of democratization of Macedonia and of negotiations between the two states over the name of
Macedonia, or rather over how this name can be used in international relations. These are
political risks, which can have significant economic consequences, mainly for Macedonia, but do
not generate the type of animosity that can bring in grave security risks. They, however, can have
negative consequences for bilateral and regional cooperation, of course.
Constitutional and problems with democratization can be solved only in the “wider
context” as Jean Monnet argued for Europe as a whole. This has proved true for the other Balkan
countries now member states of the European Union – Greece, Bulgaria and Romania – and these
countries should be expected to be exceptionally supportive of these integrative processes that
should substitute geography of animosity with that of cooperation. So far, their membership in
the EU or their expectation to join the EU has led them to stay out of most of the Balkan
animosities and problems, though their positive contribution could have been larger. The same
goes for the countries like Croatia that hopes to join EU in the near future. Its policy towards the
Balkan region has improved noticeably after it has become candidate country for EU
membership.
The fact that a country becomes more cooperative once it is in the EU points to another
important characteristic of the Balkan geography of cooperation. Regional cooperation is not very
developed and certainly does not have strong influence on the politics of the countries in the
Balkans. Therefore, it is the cooperation with the EU that enhances regional normalization and
cooperation. Regional cooperation is one of the conditions for EU membership, but the more
13
important determinant is the asymmetry in economic dependence on the EU and on regional
cooperation. Trade and most other economic relations with the EU are much more important for
every country in the Balkans then regional cooperation. Even in the case of the countries like
Serbia that trades a lot in the region, it is the EU that is potentially the main source of growth and
development.

Development Issues
In terms of trade, the Balkans does look as a developing region. If that is the case, is there an
issue of choosing policies of transition vs. development policies? This is an interesting question
which necessitates a bit of an introduction to discuss.
Dani Rodrik has been arguing that policies of development are necessarily of second best
type (see most recently Rodrik and Subramanian 2008). That means that is, for instance, trade
liberalization is good in the first best world, it may not be an advisable policy in the second best
world. Similarly, if capital account liberalization, with the view of increasing foreign investments is a
first best policy in the case of developing countries, it may not be appropriate for developing
countries, which need second best policies. Thus, policies of development may be such to require the
use of protectionist measures and control of capital and financial inflows.
He has in particular made and argument that capital account liberalization has detrimental
effects for exports because large inflows of foreign financing tends to lead to real exchange rate
appreciation, which is good for the services sector, that is mostly for non-tradable goods, but not for
exports. The overall consequence is deteriorating external balances that lead to lower growth rates
over the medium or long run.
Developments in NMS, at least in Central European economies in transition, seem to
indicate that policies of transition are the first best and not the second best policies. These countries
have liberalized trade and investments and have achieved quite dramatic growth of exports as well as
sustained GDP growth. The question then is, if this argument sounds persuasive, are Balkan
economies such that they would be better served by policies of transition or by polices of
development? There are strong arguments in both directions.
On one hand, there is significant weakness in the trading sector and there are indications that
real exchange rate appreciation is mainly benefiting the sector of services. On the other hand, the
sustained strong growth of exports, especially in the last several years, after significant elements of
transition agenda have been implemented, seem to point in the direction that the Balkan countries in
14
transition are repeating the experience of the more developed countries that have already joined the
European Union.

Conclusion
Balkan economies in transition have significant weaknesses in their exporting sectors and are
suffering from large external imbalances. However, foreign investments are growing and so are
exports. Micro evidence also indicates that there is some improvement in the structure of exports,
though reindustrialization is yet to happen. Overall, transition policies seem to be better suited than
development policies, though the jury is still out on that one.
Security and political risks still weigh heavily on the region. If the last remaining security
risk is removed, the Balkans should forge ahead in its integration with the European Union and
that will enlarge the geography of cooperation in that region too.

15
References
Christie, E. (2004), “Trade Flows in Southeast Europe”, wiiw Working Paper.
Damjan, J. et al. (2006), “The effect of trade liberalization in South-Eastern European countries”,
wiiw Working Paper.
Gligorov, V. (1996), “Trade and Investment in the Balkans”, wiiw Research Report.
Gligorov, V. (2007), “Transition, Integration, and Development in Southeast Europe” Ekonomski
pregled.
Rodrik, D., A. Subramanian (2008), “Why Did Financial Globalization Disappoint”, Working Paper.

16