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Speeches & Transcripts

Remarks by the World Bank Country Manager at the International Conference on Activating the Sources of Economic Growth in Kosovo

May 18, 2015

Jan-Peter Olters Riinvest's 20th anniversary International Conference on Activating the Sources of Economic Growth in Kosovo Pristina, Kosovo

As Prepared for Delivery

Austerity versus growth. This has been—and still is—an intensely debated in Europe (and elsewhere). But, ultimately, with related decisions (to be) taken in dynamic and global contexts being far more complicated than economic models could handle, the austerity/growth debate seemed to have alluded to—ultimately deceptive—policy dilemmas for governments in search of appropriate responses to the respective fall-outs from the global financial and eurozone crises.

This complexity is reflected in unclear correlations: neither have countries with high budgetary deficits escaped economic recessions in the post-2008 context more quickly than those that have paid more attention to the longer-term implications of Keynesian counter-cyclicality, nor have those with a more prudent fiscal policy stance slid even deeper into economic misery. This is as true for the countries in the eurozone as much as it is in the Western Balkans.

Kosovo, of all places, has intuitively understood that the link between budgetary deficits and socio-economic development objectives is considerably more complicated than the simple austerity/growth dichotomy. And to the country’s credit, for the most part, it has conducted fiscal policies consistent with this understanding.

Clearly, one important factor in this outcome has been the fact that Kosovo never had any real choice in this. Classical instruments of macroeconomic stimulation are unavailable to its policy-makers. As Kosovo has adopted the euro as its sole legal tender, the central bank is precluded from any attempt to boost growth by monetary or exchange rate policies. Similarly, the Minister of Finance (as he has just outlined in his address to you) is restrained—with very tight constitutional and legal ropes—from adopting an expansionary crisis response or from attempting a macro-economic “short cut” approach to development.

In fact, it have been the election-inspired decisions to increase aggregate demand—by (i) introducing new social benefits to political prisoners and war veterans; (ii) increasing public sector salaries; and (iii) committing to new, large-scale investment projects in the transport sector—that are the root cause of the fiscal challenges faced by today’s government and are risking a pro-cyclical policy stance in years to come. There are very few countries with a similarly tight fiscal framework, and any attempt by the new government to define own policy priorities runs into binding legal and constitutional constraints. Not only is foreign financing limited to national development priorities—as reflected in the need to have every loan be ratified by a 2/3-majority in Parliament—but also does the Minister of Finance need to devise budgetary policies under the fiscal rule, limiting budgetary deficits (with only few exceptions) to 2 percent of GDP, and the obligation that a mid-year budget revision cannot increase the budgetary deficit beyond the one specified in the original budget.

This has a direct impact on today’s policies. The unrealistically optimistic revenue projections contained in the 2015 budget largely inherited from the previous government (i) pose a serious policy dilemma between the objective of re-establishing budgetary credibility (especially on the revenue side) and maintaining the budget’s constitutionality and legality; and (ii) make even more burning the question of the government’s role in fostering socio-economic development in Kosovo.

In this audience, it is—I am convinced—well understood that Kosovo’s economy, while having (i) recorded consistently solid growth rates over the last decade; (ii) maintained macro-fiscal stability (with average budget deficits of less than 2 per cent of GDP during 2008–14 and a stock of public debt of less than 11 per cent of GDP); and (iii) developed a healthy, liquid, and profitable banking sector, has not succeeded in generating economic perspectives for discouraged jobseekers and unemployed (especially difficult for women and youth).

But it is not only the legal and constitutional constraints that prevent Kosovo from using expansionary fiscal policies as a macro-economic policy tool for stimulating aggregate demand and fuelling growth. Even if we assume that none of these restrictions existed, the structure of Kosovo’s economy is such that it would not work if attempted. In fact, the 25 per cent increase in public sector salaries—a miniature version of the Friedmanesque helicopter drop—has not resulted in a measureable acceleration of growth, largely because of Kosovo’s exceptionally narrow production base and, consequently, high rate of import dependency.

That is, the Keynesian concept of an income multiplier, whereby any euro of additional income circulates within a (closed) economy to generate additional incomes for others along the way, is largely inapplicable in the present context, when the initial boost to aggregate demand immediately leaks out of the economy as most of the acquired goods and services have been imported. This is a help to the economic recovery of economies in, mainly, the European Union—but it is not Kosovo’s role… There are still enough challenges that, first, need to be addressed internally.

The consistently very high current-account and trade deficits, which are the consequence of the import dependency, point to the principal underlying challenges for Kosovo’s policy-makers—viz., to implement a reform programme aimed at increasing domestic productivity, having key sectors of their economy catch up with know-how and standards prevailing closer to the technological frontiers elsewhere in Europe and the world, and allowing goods and services “made in Kosovo” to be competitive in domestic and foreign markets. And the only way to “import” the necessary know-how and knowledge is to be open to the outside world, open in terms of (i) supporting students, researchers, and professionals to benefit from foreign education and exposure; and (ii) attracting foreign direct investments of the scale, scope, and quality to trigger innovation and “endogenise” economic growth.

At this point, the shape of main pillars of a comprehensive socio-economic development strategy starts to stand out against the myriad of needs and wants in a country, in which average per capita income is about 11 per cent of the corresponding figure for the EU as a whole. This means, to be able to catch up with the EU over the lifespan of a generation, growth rates in Kosovo need to be considerably—and consistently—higher than in the EU. The first implication is, of course, that any development strategy, growth plan, or economic model aimed at raising Kosovars’ living standards to levels prevailing elsewhere in the EU has to be much longer term in nature than any government’s term in office, and it needs to rest on the foundations of a core consensus among the various competing political groupings, irrespective of whether they are currently inside and out of government.

That said, for a long-term growth strategy to be sustainable over several changes in government, it has to rest on an institutional foundation that accompanies resultant changes and buffers social tensions. Experience has shown that effective social policies need to assure the inclusiveness of benefits across the entire income distribution. The mining sector cannot be developed without a resettlement policy that will not leave affected households worse off; energy generation can only be secured if prices remain affordable and social and environmental challenges are addressed upfront; and privatizations need to ensure the safe transition into alternative employments of those employees whose skill set does not match the requirements of the new owners.

Within this context, the principal pillars of a comprehensive, long-term growth strategy that is to (i) effect catch-up growth with Europe; (ii) increase productivity in key sectors of Kosovo’s economy; and (iii) generate ample, high-quality, and well-paying employment opportunities—as I see them—look as follows:

First, education—and here with a particular focus on the quality of education. There is a solid body of empirical research that shows that it is the quality of education, not university degrees per se, that has powerful effects on an individual’s—and, in the aggregate—on a country’s growth and development potential. In the end, a country’s distribution of income tends to be correlated to, if not caused by, the distribution of skills.

Second, the rule of law, investment climate, and effective government. For the private sector—domestic and foreign—to choose Kosovo as its preferred location of economic activity, it needs to have confidence—confidence in the future, in the rules of the game, including their enforcement, and the ability to project, with a sufficient degree of accuracy, costs and benefits from any economy activity. Can the private sector be enticed to invest? Do households see an economic perspective for themselves and their children? In this, Kosovo has the benefit that a serious policy agenda aimed at reinforcing the functioning of government and strengthening the investment climate will help to achieve the country’s two overarching policy goals, viz., to accelerate European integration and socio-economic development.

And last but not least, infrastructure, especially in energy. This can be a very long discussion, but I’ll keep it short. Kosovo needs to upgrade its highly inefficient, polluting, and fragile energy generation capacities to (i) achieve energy security; (ii) ensure energy affordability; and (iii) minimise and manage the related environmental and social impacts. Contrary to the transport sector, current plans of energy-sector infrastructure investments rest on a public-private partnership. I will not hide the fact that the challenge of implementing a comprehensive, multi-pronged energy strategy in line with the EU’s environmental acquis communautaire has proven exceptionally complex, but recent developments allow for cautious optimism.

Medium-term success in these three areas have the potential of transforming Kosovo’s economy and opening the doors for serious interest in the—largely stunted—manufacturing and industrial sectors. They all require a strong focus and across-the-aisle commitment on corresponding reforms to (i) strengthen the overarching legal framework and/or the implementation of relevant laws; (ii) reinforce responsible public institutions; and (iii) assure transparency, access, and inclusion.

Conceptually, it does not seem impossible to design, devise, and implement a comprehensive, long-term growth strategy with which to improve the very difficult situation on the labour market tangibly: maintain a strong macro-fiscal and financial foundation, ensure a functioning market economy, import knowledge and know-how from abroad, encourage savings and investments, increase the quality of education, and overcome the most binding infrastructure bottlenecks in, especially, energy.

As Prime Minister Mustafa can attest, political reality does not always help in the implementation of such a programme. So it is the vision and long-term time horizon, the ability to influence even the most sceptic audience, as well as courage and determination that I wish policy-makers and stakeholders for the time until Riinvest’s golden anniversary.