Preparing for Prosperity: Montenegro and the Next Steps for Economic Growth

It has been nearly five years since the onset of the global financial crisis and countries throughout the world continue to cope with unflagging economic uncertainty and growing social and economic burdens. These burdens are taking their toll on countries throughout Europe – among them Montenegro. Although Montenegro has been an economic standout among countries in Southeast Europe over the last decade, stalling economic growth and stagnant job creation are now hampering the country’s ability to continue its economic progress.

Gross national income has tripled in Montenegro since 2003 – rising from $2,400 to $7,160 – and the country now has the highest per capita income among the six countries comprising South East Europe – Albania, Bosnia and Herzegovina, Kosovo, the Former Republic of Macedonia, Montenegro and Serbia. Furthermore, poverty in the country declined from 11.3 percent in 2005 to 9.3 in 2011 (the last year data was available) percent and the country maintains a relatively moderate inequality of income.    

However, as the global recession continues these economic and social successes are being offset by negative trends in the country. Following a credit consumption boom and real estate bubble between 2006-08, real Gross Domestic Product (GDP) fell by nearly 6 percent in 2009 and after recovering some growth in 2010-2011, it slipped into recession again in 2012. Unemployment – at 20 percent – remains very high and consumer debt is suppressing consumption in the country. It is clear that the global economy has now shifted and Montenegro needs to begin adapting to this new global economic landscape if it wishes to return to the economic gains of the pre-crisis years.

Above all, any measure Montenegro takes should focus on increasing economic growth in the country. Higher growth – even a slight increase – could significantly improve living standards throughout the country if sustained over a longer period. The question of how to achieve this growth, however, remains.

Until now, Montenegro has followed an economic growth model emphasizing capital inputs, Foreign Direct Investment (FDI), and a steady supply of inexpensive capital. Productivity growth in Montenegro, on the other hand, has been virtually non-existent. While this model proved effective in the years leading up to 2008, the economic shocks of the ongoing crisis have now exposed the vulnerabilities of this model, highlighting the need for Montenegro to adapt its economic policies.

In response to this need a new Country Economic Memorandum (CEM) has been developed which explores areas where Montenegro can begin making adjustments in order to better adapt to this new economic reality and begin creating the necessary conditions for a new economic model.

“Montenegro is an exciting place to do business” says Zeljko Bogetic, World Bank Lead Economist and lead author of the report, “it has a great location and is well positioned in Europe to take advantage of both regional and global markets.  Unfortunately, the country is not making the best of these advantages.”

The new CEM, titled Montenegro: Preparing for Prosperity – Ensuring Sustainability, Connectivity, and Flexibility for Dynamic Growth, was developed to help the country begin exploiting these advantages. The report utilizes a three pronged-approach that can help the country develop a growth model capable of driving Montenegro into the next stage of development in an increasingly competitive international environment. Recognizing that no single method of analyzing growth constraints can provide the necessary recommendations for comprehensive reform, this report emphasizes an overarching approach that incorporates sustainability, connectivity, and flexibility. By taking a flexible approach in regulatory and institutional development, the CEM argues, Montenegro can capitalize on its connectivity – via trade, infrastructure and human capital – to ensure the kind of macroeconomic stability and sustainability necessary for long-term growth.  

How to take advantage

This report utilizes the three building blocks of sustainability, connectivity, and flexibility to provide recommendations to Montenegro on key areas for the development of future policies that can significantly improve the country’s business environment for investments and growth. Some key findings from that analysis include:

Sustainability

• Productivity will ensure sustainable growth – A productivity growth rate of just 0.6 percent could allow for a growth rate of four percent or more in Montenegro.  This growth rate over several decades could prove to be truly transformational for Montenegrin incomes and living standards.  The keys to this growth are knowledge, skills, and education. 
  
• Fiscal reform is key – With public and publicly guaranteed debt exceeding 62% of GDP in Montenegro, it is imperative that the country move toward fiscal surpluses, build fiscal reserves, eliminate municipal arrears, and adopt and enforce credible fiscal rules. 
  
• Improvements in Montenegro’s banking system are necessary for growth –  Although the country’s banking system is now more robust than when the global crisis began, the country’s share of non-productive loans remains around 17 percent, highlighting the need for continued reforms.  These reforms should emphasize the need to extend basic services to underserved segments of the population, improve bank controls, and increase regulations and supervision directed at credit risk management.
  
  

Connectivity

• Information and Communication Technologies (ICT) offer huge opportunities for Montenegro – ICT can help strengthen the country’s competitiveness, investment climate, and innovative capacity and positioning Montenegro to become a vibrant innovation hub linking the Balkans to the rest of Europe – and the entire global economy.  Strategic investment in ICT infrastructure and related skills – especially in broadband, open data, and e-commerce – can pay huge dividends in terms of growth and high-wage jobs in the country. 
  
•  Promote exports – In order to improve overall connectivity with the region, as well as the global market, the country needs to make exports a top priority.  In doing so, Montenegro should also work to dismantle remaining trade barriers, ensure wide export certification in the private sector, and attract export oriented Foreign Direct Investment (FDI). 
  
• Improve transport and energy connectivity – Long term sustainability requires Montenegro to begin focusing on the quality of their roads, their overall North-South connectivity corridors, road safety and improved rail links.  These improvements in transportation need to be implemented in tandem with improved energy connectivity – including improved cost recovery and tariff structures, expanded energy efficiency measures, and broader connectivity to regional markets.

Flexibility

• Flexibility needs to be exercised when reinforcing areas which attract investment – Many problematic areas in the investment climate are related to the depressed housing and construction industry, the informal sector, remaining trade barriers, and the impact of local fees and taxes on investments. Cost should be reduced for entry and operation in construction and housing. The implementation of a flexible agenda that reduces bureaucracy and reforms taxation will benefit Montenegro in the years to come. 
  
• Improve product market and labor market regulations – Reducing state control in areas where Montenegro lags behind other countries in the Organization for Economic Co-operation and Development (OECD) can help with these improvements. Improvements can include reducing barriers to entrepreneurship, optimizing one-stop shops for businesses, and reducing the cost of construction permits.
  
• Refine labor market regulations that allow for a variety of employment contracts and durations – In order to eradicate disincentives to creating jobs in the country the country needs to eliminate the maximum duration of fixed-term contracts, gradually increase the early retirement age, and reduce social security contributions and shift the tax burden to consumption taxes.