Reform Momentum Needed

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The Western Balkan economies are projected to continue to grow in 2019–20, but this outlook is vulnerable to risks.

In 2018, economic growth in the Western Balkans reached 3.8 percent, supported by increased public spending, and in Albania and North Macedonia by a rise in net exports. Growth is projected to average 3.7 percent for 2019–20, faster than the EU and similar to the average for Central and Eastern Europe (CEE). Growth will differ by country, accelerating in Bosnia and Herzegovina, Kosovo, and North Macedonia, while decelerating in Albania, Montenegro, and Serbia.

Factors common to all countries are the recent fiscal stimuli and favorable external conditions that pushed growth in 2018. The waning effects of these factors challenge the medium-term growth outlook in the region. Western Balkan countries are confronted with growing external and domestic risks. Against this backdrop, there is an opportunity to advance reforms to mitigate risks and demands for greater economic opportunities.

Despite stronger growth in 2018, job creation slowed, reflecting limited private sector dynamism.

In 2018, 96,000 jobs were created in the Western Balkans (mostly in industry and services), down from 171,200 jobs created in 2017. The slower labor market response reflects to some extent the temporary effects of the fiscal stimuli that pushed growth, but did not encourage private sector job creation. Unemployment fell in 2018 but remains high, particularly for women and youth.

In some countries, the fall in unemployment stemmed from increased labor inactivity and emigration rather than new jobs. Labor market distortions at the country level remain evident in regional and gender disparities. Reducing disincentives to employment and labor force participation, such as the high burden of taxes on low-wage earners, is critical to spur job creation and growth.

Ensuring firms can enter, compete on equal terms, and efficiently exit the market would support business development and attract private investment.

In recent years, foreign direct investment (FDI) has helped transform industries and increase exports, but FDI is still low as a share of GDP. Regulatory barriers make it difficult for existing firms to expand or exit the market, and for new firms to succeed.

High-growth firms — which grow on average by at least 20 percent for three consecutive years — create the most jobs in the Western Balkans, but there are few of these firms (in 2016, only 1 in 33 formal sector firms in North Macedonia, and in 2017, only 1 in 20 firms in Serbia). Other small transition economies in Europe, such as Latvia, Lithuania, and Estonia, have much larger shares of high-growth firms. 

Public spending is dominated by large public wage bills and untargeted social programs.

Countries that have been committed to fiscal consolidation, such as Albania and Serbia, are seeing their debt go down, and it is critical to safeguard these gains. But public and publicly guaranteed debt remains high in most countries, and rose in Montenegro, North Macedonia, and Kosovo in 2018. Fiscal risks related to pensions, municipal finances, and state-owned enterprises are also on the rise.   

It is vital to build reform momentum to ensure foundations for future growth.

This edition of the report discusses reform areas that will help boost productivity for faster and sustained growth and jobs: competition policy; labor taxation; the distributional impact of personal income taxation; financial sector diversification; export sophistication; and economic connectivity. Advancing reforms in these areas would allow Western Balkan countries to seize the opportunities that EU accession can bring, and to be able to compete on an equal footing with EU peers.

Human capital challenges in the region.

If left unaddressed, human capital challenges will severely limit the prospects for growth and poverty reduction. Investing in early childhood development would help improve performance in primary and secondary education, and empower students with the skills employers need. Better targeted social assistance programs would help protect poor and vulnerable households from shocks. And more efficient health systems would help address the rise of non-communicable diseases and reduce out-of-pocket spending on health.