Economic and Social Reforms for Peace and Reconciliation

Prepared by the World Bank

February 1, 2001

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There is wide consensus within Kosovo society that the twin challenges faced by the economy are recovery from the long decades of lack of basic productive investment and even routine maintenance of infrastructure and services exacerbated by conflict-related damage to part of the capital stock, and the creation of incentives and institutions to make a rapid transition to a market economy. This vision is shared by the interim civil administration of Kosovo (UNMIK) and, indeed, by the donor community at large.

Transition in Kosovo has to take place against the background of not only the legacy of Yugoslav-style planning and social ownership but also the constitutional peculiarities and political uncertainties of the present. No representative institutions at the provincial level exist today; yet, transition requires local consent and, indeed, whole-hearted participation. Transition is also handicapped by the long period of exclusion from civic participation of the Albanian Kosovars and by the tradition of parallel institutions and informal, at times criminal, ways of operating, e.g., in revenue raising. It is, however, assisted by a strong wish to build a market economy and the demonstrated entrepreneurial spirit of the people. The key policies and associated institutional developments required for transition together with the political economy context of the post-conflict period are discussed below.

Within the framework of UN Security Council Resolution 1244 that balances continued sovereignty of the Federal Republic of Yugoslavia with substantial autonomy and self-government for Kosovo,¹ UNMIK has issued two general regulations (Regulations 1 and 24) clarifying that FRY laws applicable in Kosovo until the suspension of the autonomy of the province in 1989 continue to apply unless invalidated on human rights grounds or superseded by UNMIK regulations. Certain laws passed after 1989 will also be enforced on a case by case basis if considered to be consistent with standards of human rights and also if they are considered to be in the interests of the province.

More specifically, on economic policy matters, UNMIK has taken a pragmatic approach, balancing the considerations of sovereignty and autonomy. On the one hand, the trade and customs regimes that were inherited from the FRY were found to be severely distortionary with widespread exemptions from rules and a high degree of discretionary as opposed to rule-based authority. Clearly, such regimes were inimical to the interests of promoting efficient, private sector led growth, and were, therefore, radically re-shaped. A thoroughly revised tax system and a tax administration system were instituted to replace the unsatisfactory FRY system. The system of bank licensing and supervision was overhauled to modern standards of effective surveillance and prudence. The payments system was reformed with the abolition of the FRY-style public monopoly over payments and the creation of a market-based system. Thus, modern, efficient policies and structures were put in place, but the accomplishment of the final results will, of course, take time.

These actions were essential to provide support for private sector growth and investment and to ensure rising local financing for expenditures. On the other hand, no independent currency is to be issued, nor a central bank established; rather, the use of the deutsche mark and other foreign currencies was legalized, whilst the FRY dinar continues to be the legal tender. Decisions on the degree to which substantial autonomy and self-government will be exercised in Kosovo remain to be taken in some sensitive economic areas, such as ownership of state and socially owned property, international commercial contracts and commercial laws.

Despite the clarifications or developments in policies and laws described above, there remains a considerable degree of uncertainty about the shape and timing of an eventual political settlement for Kosovo. The gulf between the parties to the discussions is wide and the dialogue on this question practically non-existent.² The inception of a post-Milosevic democratic government of FRY has added a further dimension to the debate. The continuing uncertainty regarding the constitutional future of Kosovo is bound to damage investment, particularly foreign investment, and growth prospects. There is an obvious need to clarify constitutional arrangements prior to the hand over of substantive authority to a representative administration elected on a province-wide basis, expected to take place next year. While the Special Representative of the Secretary General of the UN will continue to exercise supreme authority under resolution 1244, the responsibilities of the representative administration and the extent of its autonomous powers will have to be established.

Whilst there is acceptance of the need for a UN administration in Kosovo for a period, the populace is clearly anxious to see representative government formed. This reflects pent-up yearnings for civic participation in all walks of life after a decade of exclusion. Both the major local political parties see themselves as provincial governments in waiting, and have developed shadow ministries and town councils with their own budgets that provide some public services financed through diaspora funds or illegal local revenue raising. These structures, parallel to the UNMIK administration, were to have been totally dissolved in early 2000 as a part of the agreement with UNMIK that broadened local participation in Kosovo’s administration (see paragraph 18 below); it appears that while some parallel institutions have been formally abolished, some significant parallel activities and budgets continue to exist.

The considerable local pressures for elections at both the provincial assembly and the municipal levels led UNMIK to hold municipal elections in October 2000. The first free political campaign in Kosovo for decades was conducted, on the whole, peacefully and with a keen sense of competition. Elections, supervised by the OSCE, saw a high turn-out by the Kosovar Albanians, but a total boycott by Kosovar Serbs. They resulted in a clear victory for the long-established party led by Ibrahim Rugova with nearly 60 per cent of the vote and a second place for the political party associated with the liberation army led by Hashim Thaçi with nearly 30 per cent of the vote. Municipal councils are expected to take power by end-2000. These councils will continue to be supervised by UNMIK representatives. Although all parties have stated that they respect the election results, a major challenge is likely to be to induce incumbent councilors (often nominated by political or other interests) to give up effective power to those elected. A further challenge to the efficient functioning of municipalities is lack of clear structures or clear lines of authority and responsibility regarding permissible municipal functions and powers at the municipal level to raise revenues. These structural issues are still under design by UNMIK.

Box 1: Governance Arrangements in Kosovo

It is expected that provincial elections will be held in 2001 with a transfer of power rapidly thereafter to a provincial government that enjoyed the support of the elected assembly. As noted, the constitutional powers of such a government are still to be decided. For both the major political groupings, independence remains a cardinal objective, with little thought having been given to the limitations posed by Resolution 1244. Indeed, the constraints posed more widely by Kosovo's constitutional status as a province of FRY feature little in local political thinking.

From its inception as the interim government of Kosovo under Resolution 1244, UNMIK had established a forum for consultation with local opinion in the formulation of economic and other policies. Thus, the Kosovo Transitional Council (KTC) was formed with high level local political representation (see Box 1). This initiative was deepened through formal advisory boards or joint consultative councils permitting Kosovars a formal role in the design of policies. UNMIK undertook to consult the Kosovo Transitional Council before any regulations were issued or important political decisions taken. Likewise, joint consultative groups were established in the administrative district levels and in some of the municipalities.

In economic institutions, such as the banking and payments agency (charged with supervising banks and operating the payments system), the central fiscal agency, customs administration, education and health policy making, provision was made for a significant role for Kosovars in providing advice to UNMIK. UNMIK declared that this advice would be given great weight before final decisions were taken. An Economic Policy Advisory Board with UNMIK and local representation was established. The role of Kosovars was envisaged to be substantial also in the implementation of policies, e.g., in the banking and payments institutions and in the central fiscal agency. Municipal councils, in the pre-election period, were formed to a standard approved by UNMIK with community representation; and these councils were given authority in essential public service delivery.

These early initiatives for local Kosovar participation in economic governance described above were greatly strengthened and formalized in January 2000 with the establishment of the Joint Interim Administrative Structure (JIAS). The JIAS permitted the continued functioning of the KTC as the highest level body (under the supreme authority of the Special Representative of the Secretary-General of the UN), but created an Interim Administrative Council (IAC) with policy making and law-proposing powers as well as with supervisory powers over all civilian affairs (with the exception of policing and other aspects of security) to report to the KTC. The IAC has four foreign members and four Kosovars – three ethnic Albanians and one ethnic Serb. Twenty administrative departments were created (akin to ministries), each with UNMIK and local Kosovar co-heads, to carry out the normal functions of a government. Each such department is headed jointly by UNMIK international and Kosovar staff, and each department has both international and Kosovar staff.

Following the municipal elections of October 2000, UNMIK announced a decision to reconstitute the membership of the KTC and the JIAS to reflect more closely the results of the election. It would also be advisable to use the opportunity of this reconstitution to simplify the administrative structure and, in particular, to grossly reduce the number of government departments. At the same time, UNMIK announced that a formal grouping of the 20 department co-heads would be constituted as a Council of Ministers, a body intended to discuss economic policies and their implementation.

All major strands of Kosovo’s local political leadership support the objective of a private market based economy with open trade and investment regimes and integration with the other economies of Europe. The articulation of a clear vision and the path of transition that Kosovo must follow in its economic and social development are tasks that the political leadership must now address. The economic institutions necessary to undertake such a transformation have also not been reflected upon. In the absence of such policy or institutional work or debate within society and even in the absence of a widely shared common vision and consensus on the transition path, there is today an overwhelming nostalgia for 1989, the last year of autonomy under the SFRY constitution. Indeed, that year is seen as the last year of a golden epoch when public enterprises employed ethnic Albanians, civic institutions functioned satisfactorily, and standards of living rose steadily. This nostalgia is as strong today – one and a half years after the cessation of the conflict -- as it was in its immediate aftermath.

The view is widespread that government institutions, utilities, enterprises, ought to be restored to what they were in that year, with the guaranteed employment that went with it. Such factors as the fundamental unviability of many public sector economic activities that in 1989 were propped up by cheap credits or outright grants, captive markets, and other subsidies from the FRY development funds, as well as the rapidly changed world market conditions and technologies of today – all of which make industrial revival inadvisable – are still to enter public consciousness. Moreover, the necessity of nurturing a private sector based economy and contemporary standards of governance, as opposed to the corrupt ways of the FRY nomenklatura, make the reference point of 1989 fundamentally an unrealistic one. A major task for UNMIK and the international institutions will be to help develop viable transition strategies and institutions, and build public support for them.

The centralized administration of Kosovo in the decade to the conflict of spring 1999 and the exclusion of Kosovar Albanians from participation in government, civic institutions and in public enterprises were developments that led to a degree of erosion of skills amongst the majority ethnic group in Kosovo with an accompanying atrophy of the practices and traditions of representative politics, self-government, and administrative skills. The challenge now is to re-build governing institutions, at legislative and executive levels, with standards of governance and transparency, and to inculcate skills. The JIAS structure provides a framework for the establishment of ministries and other public agencies and to undertake public administration. In this task of skill formation and the development of a democratic, meritocratic culture, the experience accumulated from the years of operating the parallel systems in education and health would be helpful, but it should be noted that the standards and methods required for a formal government system to operate properly imply considerable re-learning and adaptations of civic and political behavior in the direction of a consensual framework for decision making.

One aspect of institutional development is the degree of power sharing between a central provincial authority and the municipalities. There is a clear trend towards decentralization. As a reaction to centralized rule from Belgrade and from unrepresentative institutions in Pristina over the past decade, strong preferences for fiscal and economic devolution are evident, with key powers envisaged for the municipalities. Whilst it is agreed that much revenue collection will have to be centralized, expenditures and service delivery are seen as municipal responsibilities, with choice at municipal levels being accorded much weight. In view of the post-conflict concentration of the Serb ethnic minority in a few municipalities, this appears the only way for providing discretion in allocating resources within sectors such as for education services.

* The challenge of sustainability. The political economy factors discussed above have a strong bearing on the sustainability of economic policies and economic institutions in Kosovo and on both internal and external sources of support that are required for the province to be self-sustaining. In the absence of a clear vision for the final political and constitutional settlement for Kosovo and a firm trajectory for attaining that settlement, the parameters for achieving sustainability are hard to define. For example, what degree of external support – economic, financial, political, security – can be assumed over the medium term? Can sustainable political and civic institutions be built contemporaneously with external administration of the UNMIK kind? The development of responsible local administration, of representation, of accountability can best take place if supreme political and constitutional authority is defined in a permanent manner. Thus, civic and political sustainability depends on the definition of the future constitutional position of Kosovo, in particular, its relation with the rest of Serbia, with its neighbors and its authority and ability to exert a well-defined, well understood, and well-clarified degree of autonomy.

Moreover, economic viability clearly depends greatly on tailoring the aspirations of the populace to the resources available over the short and medium terms and ensuring that public expenditures and welfare programs fall within these constraints of resource availability. External donors have made clear the provision of approximately US$2 billion of support over a three to four year period for reconstruction and investment activities plus sufficient support (approximately US$150 million) ; (ii) pressures on expenditures from greater than budgeted outlays for public utility subsidies; (iii) the structure, types and levels of social assistance benefits that are designed more for the conditions of the prosperous countries in the EU rather than the straitened circumstances of Kosovo; and (iv) poor state of public management and weaknesses in the functioning of the administrative apparatus, partly for reasons of capacity, and partly for the political economy factors, including ethnic tension, discussed above. These challenges to economic viability are discussed in summary in the rest of this volume and in detail in the second volume of this report.

Some preliminary conclusions on sustainability may be noted. It is surely the case that as yet there is no light at the end of the tunnel – constitutional or economic. The current international effort of starting reconstruction, providing basic public services, and initiating the creation of essential institutions is necessary and appropriate as the immediate post-conflict response, but sustainable patterns of public spending and public institutions will only be determined when the constitutional and economic frameworks are clearly defined.

¹ Resolution 1244, paragraph 11.

² UNMIK is charged with facilitating a political process designed to determine Kosovo’s future status, taking into account the Rambouillet accords (paragraph 11 of the resolution).