Reinforcing Conditions for Productivity Growth

February 2, 2012

Jan-Peter Olters

Reinforcing Conditions for Productivity Growth

Jan-Peter Olters
Country Manager, World Bank Office in Kosovo

Published in: The Horizon (American Chamber of Commerce in Kosovo), February 2012, pp. 12–13.

Only three years after the financial crisis had brought the world economy to its knees, firms, households, and governments have become pre-occupied—yet again—by the prospect of a global recession. This time, root causes are unsustainable public-debt levels in parts of the eurozone (and the US), leaving investors alarmed, banks unsettled, and households under stress. Economic forecasts for 2012 have been made difficult by the fact that policy responses to mounting financial pressures have remained underwhelming. To varying degrees, countries in the Western Balkans were hit hard by the previous crisis, and they are left struggling in their attempts to regain the fiscal space necessary to cushion harmful socio-economic effects from another downturn. As argued in the World Bank’s recently published South East Europe Regular Economic Report (RER), the effects of a further global slowdown—and especially prolonged uncertainties around the eurozone—would impact the economies in the Western Balkans through trade, foreign direct investment (FDI), foreign banks, and remittances.

Kosovo is no exception, even though it might be less exposed to related effects than its neighbors. Main arguments for this assessment would comprise (i) Kosovo’s relatively lower trade integration with the EU; (ii) the comparatively higher degree of income stability of the diaspora concentrated in less vulnerable countries (Germany and Switzerland); (iii) the healthy liquidity and capitalization ratios of banks; and (iv) the soundness of the fiscal position. At about 7 percent of GDP, public debt at end-2010 compares favorably even to star performers such as Estonia, Bulgaria, or Luxembourg. Not least because of the fiscal nature of the present financial-market turmoil, the low level of public indebtedness provides a critically important ingredient to potential investors’ assessment of Kosovo’s relative attractiveness.

In fact, of the six potential indicators of vulnerabilities that the RER has identified, Kosovo finds itself in the “danger zone” with only one of them—viz., high (and rising) current-account deficits (meaning that exports of goods and services pay for only a small fraction of imports). Additional efforts will thus have to be made to increase the efficiency of production to allow for increased import substitution and/or exports. This focus is particularly important as Kosovo uses the euro as sole legal tender, implying that policymakers are precluded from using currency depreciation as an instrument to boost international competitiveness and/or offset wage increases in excess of productivity growth. This leaves Kosovo with few options but to address structural and institutional bottlenecks directly and, in so doing, aim at increasing domestic productivity and narrowing the gap with higher-income countries in skills, technology, and infrastructure. This can be done most directly and effectively by attracting strategic investments from companies that bring in, together with the capital, knowledge and expertise.

Especially in light of the difficult external conditions, Kosovo will only be able to attract FDI of the scale and scope to set off high and sustainable rates of (domestic productivity) growth if economic policymakers manage to (i) ensure macro-fiscal stability (implying the proper preparation and tendering of large-scale public infrastructure investments); (ii) strengthen “soft” infrastructure (comprising an attractive business climate and the rule of law); and (iii) build “hard” infrastructure (with a concomitant focus on ensuring the availability of sufficient funds for maintenance). In this endeavor, the World Bank will remain a partner and increase its financial and technical support to help the government to achieve its socio-economic development objectives. It is currently discussing with Kosovo the first four-year Country Partnership Strategy with which to address some key challenges and development constraints so as to boost sustainable growth and employment and improve environmental conditions and natural-resource use. 

Given the high unemployment figures and low income levels, Kosovo will have to grow at rates considerably faster than its neighbors to be able to catch up and effect tangible improvements in living conditions. It is thus encouraging that the government has made reforms in the area of Doing Business a key policy commitment, aiming at becoming one of the top reformers in subsequent surveys. This bodes well for Kosovo’s medium-term growth potential—irrespective of developments elsewhere.