European Commission The World Bank The Road to Stability and Prosperity in South Eastern Europe
 Home
Table of Contents | Next-> Chapter 2: Economic and Social Developments and Progress on Reform in South Eastern Europe

The entire document is available in PDF format (850 KB)


The Road to Stability and Prosperity in South Eastern Europe
A Regional Strategy Paper

Chapter 1: The Road to Stability and Prosperity in South Eastern Europe—A Strategic Approach

"Almost ten years after the fall of the Berlin Wall, the Kosovo crisis has been a bloody reminder of what, in another context, we used to call ‘the cost of non-Europe’. For the current member states of the European Union, the integration process that began in the early 1950s has brought both remarkable political stability and a spectacular increase in economic well being. Conversely, the disintegration in South Eastern Europe during the past decade has exacerbated poverty and inter-ethnic hatred, and cost the lives of many thousands of innocent civilians. The comparison of these two polar cases may not constitute a very rigorous scientific demonstration, but it does provide a prima facie argument in favor of regional cooperation and progressive integration" (Hans van den Broek)1


A.  Introduction and Overview

1.1   This Report attempts to define the broad parameters of a comprehensive approach to regional development in South Eastern Europe (SEE), which in this Report refers to Albania, Bosnia and Herzegovina, Bulgaria, Croatia, the Federal Republic of Yugoslavia (Serbia and Montenegro) (FRY), the Former Yugoslav Republic of Macedonia (FYR Macedonia), and Romania. This Report develops a broad strategic framework for regional activities; it is not a blueprint for specific investment programs, projects or financing requirements. It follows the conceptual approach outlined in the Comprehensive Development Framework (CDF). The CDF takes a holistic approach to development, highlighting the interdependence of social, economic, human capital, governance, environment and financial aspects of development.2 This comprehensive approach has been developed in collaboration with the countries of the region and the World Bank’s main development partners in the region—the European Commission (EC), European Bank for Reconstruction and Development (EBRD), European Investment Bank (EIB), Organization for Economic Cooperation and Development (OECD), Council of Europe, and Council of Europe Development Bank (CEB).

1.2   The fundamental objectives of the strategy outlined in this paper are increased prosperity and a reduction in poverty for all people living in the South East European region, which can only be achieved if peace and stability are established throughout the region. A deeper and more consistent implementation of domestic reform programs, stronger governance and institutions, better environmental management and a more developed infrastructure base are all essential to achieving prosperity and a sustainable reduction in poverty. Policies to foster social inclusion and cohesion within the increasingly fragmented region are also essential to achieve both peace and prosperity.

1.3   The past decade of transition and conflict has been exceptionally difficult for the people of South Eastern Europe. Hostilities have created deep-seated resentments. Emerging from these hostilities is a polarized patchwork of nation states, formed largely along ethnic lines. Conflict, an absence of a political consensus for reform, shallow democratic traditions and weak institutions have all combined to constrain economic and political development in most countries in South Eastern Europe. In turn, delays in the implementation of reform programs have prevented economies from embarking irreversibly on the path towards becoming fully functioning market economies. Consequently, these economies have experienced an inferior economic performance and in many cases, declining living standards, rising unemployment and inadequate progress in reducing poverty.

1.4   Even five years after the Dayton Peace Agreement and now following the UN Resolution that ended the Kosovo conflict, South Eastern Europe remains politically and socially unstable. About 1.7 million people are estimated to be displaced from their homes and separated from their assets. A third of Bosnia and Herzegovina’s population are displaced. Over 300,000 Serbs from Croatia are estimated to be refugees in FRY and Bosnia and Herzegovina. Refugees and Internally Displaced People (IDPs) represent 13 percent of the population of Montenegro. The recent conflict in Kosovo added to the number of displaced persons in FRY and other neighboring countries. Continued demands for independence of ethnic groups (such as the Kosovo Albanians), and challenges to negotiated agreements also engender uncertainties. The stability of the region is also unsettled by the current political situation in FRY. Even countries, which have not been directly involved in civil and ethnic conflicts, have suffered economic, social and political consequences of the regional instability. Declining living standards, refugees, border disputes and security concerns in the region are all conspiring to create a cauldron of instability and potential conflict in Europe.

1.5   There is no denying that achieving social and political stability and sustainable development will take years for most countries. Nor will progress towards these goals be smooth or automatic. Several factors indicate how difficult this road will be. First, while steadfast reform and the clear prospect of EU accession have led to sustained economic progress in Central Europe and the Baltics, in some CIS countries, which share characteristics similar to the SEE countries, even determined implementation of reform programs has not yielded the expected positive results, because of civil conflicts, weak institutions and poor governance. Second, conflicts and ethnic tensions among the SEE countries have opened rifts that will not be easily healed. It will take time to achieve the intra-regional cooperation and trust necessary for peace and stability. These factors suggest that the concerned countries and the international community both need to make an extraordinary effort to create the conditions for peace, stability and prosperity in South Eastern Europe.

1.6   In the immediate aftermath of the cessation of hostilities in Kosovo, the international community and the countries of the SEE region have committed themselves to make a determined effort in this direction. This new approach is elaborated in the Stability Pact, which was signed by the countries in the region and the international community (see Box 1.1). The Stability Pact proposes the development of initiatives that increase regional integration, foster economic development and absorb these countries into European and global structures, especially the European Union. The effect of the pull of these countries towards Western European organizations is seen as a crucial factor in accelerating intra-regional integration and cooperation, which, in turn, would lessen tensions among the South East European countries themselves, especially those emerging from the former Yugoslavia. To this end, the European Commission is launching a process of stabilization and association with those countries of the region which are not yet associated to the EU through Europe Agreements. This was confirmed by the Heads of States and of Government of the European Union in Cologne on June 4, 1999.

1.7   The international community has a clear stake in achieving peace, stability and prosperity in South Eastern Europe. Not only will continued instabilities and stagnating economic growth adversely affect the welfare of the people of the SEE region, continued instabilities will also affect Western European economies and societies as well as other countries in the Stability Pact. The recent Kosovo crisis was a vivid reminder of this reality. An unstable region is a fertile breeding ground for crime, smuggling, illegal activities, which will not only affect the lives of people in the SEE countries but also those in neighboring societies. A more prosperous, stable SEE region would also benefit Western Europe economically, by opening up new markets for investments, sources of skilled, low wage labor and trade opportunities. As articulated in the Stability Pact, creating the conditions for peace and prosperity in the SEE region therefore should be seen not only as an objective for the SEE countries themselves, but also for the international community.

1.8   A stronger and longer-lasting commitment to reform and cooperation by the SEE countries themselves is an essential condition to overcome the legacy of disintegration and declining living standards. Without this commitment, no regional strategy can be effective. Performance in the past decade clearly indicates that reform efforts in SEE countries have been too hesitant and attempts at intra-regional cooperation inadequate to bring about sustainable growth and stability. This inadequate performance stems from country-specific difficulties—insufficient government commitment, weak governance, and low levels of investment—as well as regional instability. The situation has improved in recent years, but progress needs to be consolidated and sustained to change fundamentally prospects for peace and prosperity.

1.9   Nevertheless, it is unlikely that sustainable growth will materialize and a virtuous circle of increased prosperity and security can be established solely on the basis of national reform programs and intra-regional cooperation. As the recent Kosovo conflict has demonstrated, neighboring countries bear significant economic and political costs, even if they are not directly involved in the conflict. The continued isolation of FRY also adversely affects the region, as important trading and transport links are disrupted. Moreover, small closed economies do not have sufficient effective demand to sustain growth. Small states that are surrounded by instability and conflict will also be unattractive for investment. The strategy articulated in this paper, therefore, argues that an approach focused on country-by-country reform and intra-regional integration is necessary, but not sufficient, to achieve peace, stability and prosperity in South Eastern Europe.

Box 1.1: The Stability Pact and Donor Coordination Mechanisms

Country participation in the Stability Pact is broad and inclusive. It includes all EU members and G-8 countries, Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Hungary, Romania, Slovenia, FYR Macedonia, Turkey as well as virtually all major international organizations and regional initiatives which are active in the region. The Pact declares "that the Federal Republic of Yugoslavia will become a full and equal participant in the Stability Pact, following the political settlement of the Kosovo crisis on the basis of the principles agreed upon by G-8 Ministers and taking into account the need for respect by all participants for the principles and objectives of the Pact." (Art. 11 para. 2). Representatives from the Republic of Montenegro also attend the meetings of the Stability Pact.

The Stability Pact is being implemented through a Regional Table and three working tables, which include a Working Table on Democratization and Human Rights (Table 1), a Working Table on Economic Reconstruction, Development and Cooperation (Table 2), a Working Table on Security (Table 3). Responsibilities for each Working Table have been assigned under a Work Plan agreed by the Regional Table.1 At this point, each working table has had initial meetings and begun to address the mandates as outlined in their terms of reference.

The Stability Pact also assigns specific responsibilities to the European Commission and the World Bank. In particular, under the Stability Pact, the World Bank and the European Union are given a special mandate to coordinate a comprehensive regional approach (Art. 41) to development in the SEE region.

Also the major donors have assigned to the World Bank and the European Commission the responsibility of coordinating economic assistance to the region. To support this coordination, the European Commission and the World Bank are chairing a High-Level Steering Group (HLSG). Participants in the HLSG include the Finance Ministers of Canada, the country holding the Presidency of the EU (currently Portugal), France, Germany, Italy, Japan, Russia, the United Kingdom, and the United States, and representatives from the European Bank for Reconstruction and Development, the European Investment Bank, the International Monetary Fund, the Stability Pact for South Eastern Europe, the United Nations, the European Commission, and the World Bank. Its meetings are also being attended by the Minister of Finance of the Netherlands. The work of the HLSG is supported by a Working-Level Steering Group (WLSG). A joint World Bank-European Commission office—the Office for South East Europe—was established in Brussels to facilitate this coordination effort.

The comprehensive regional approach outlined in this Paper is in response to the Stability Pact mandate. It primarily develops themes assigned to the Working Table on Economic Reconstruction, Development and Cooperation (Working Table 2). It is thus primarily an economic development strategy. This Strategy does, however, pursue certain crosscutting themes, such as institutional programs, anticorruption measures, and interventions to encourage social cohesion, which are essential to achieving sustained economic development and which are addressed under other working tables.

1 Stability Pact for South Eastern Europe, Regional Table, Brussels, 16 September 1999, Work Plan (final).
2 The objectives of the HLSG are described in the statement of the HLSG meeting of July 13, 1999.


1.10   Success hinges critically on a credible and predictable path to integration with European and global structures, particularly the European Union. Such a path will anchor expectations and provide both an incentive for reform and intra-regional cooperation. The sustained commitments that such a path requires will facilitate political and social changes, and discipline the formulation and implementation of domestic reforms in the SEE region.3 Politically, a credible commitment of integration for this generation will give a strong incentive to today’s political leaders to move forward rapidly to improve governance and undertake reforms. Integration with the rest of Europe also raises the cost of bad neighborly policies or improper governance. Ample evidence demonstrates that economic integration with developed economies can accelerate growth, lend credibility to reforms and provide a securer environment for investors. The strategy, therefore, is built upon the assumption that a credible commitment to integration with European and global structures, especially the European Union, is a critical ingredient of success, as it will serve as an external driver of reform and intra-regional integration.

1.11   The remainder of this introductory chapter is organized as follows. The next section (Section B) provides a snap shot of the ‘region’, as well as ‘defining’ the region for the purposes of this paper. Section C describes the key elements of the proposed regional strategy. Section D summarizes the broad outlines of the domestic reform agendas in the SEE countries. Section E discusses the importance and underlying rationale of providing the SEE countries with a clear and credible commitment to join European and global structures. Section F provides a road map to the rest of the Report. The following Chapters present the analytical underpinnings of the strategy and outline the areas in which regional initiatives and programs should be developed to support the objectives of the Stability Pact.


B.  South Eastern Europe: A Brief Snapshot

1.12   The regional strategy discussed in this Report is primarily focused on seven countries, which are referred to as SEE countries or collectively as the SEE region. The countries are: Albania, Bosnia and Herzegovina (BiH), Bulgaria, Croatia, the Federal Republic of Yugoslavia (Serbia and Montenegro) (FRY), FYR Macedonia, and Romania.4 The economy of Kosovo, Federal Republic of Yugoslavia (Serbia and Montenegro) ("Kosovo") is included in the analysis and approach as much as possible. Given the scarcity of updated economic information on the economies of Montenegro and Serbia, as well as Kosovo, references are made primarily in a qualitative fashion. Moreover, the current political conditions prevailing in FRY also make it difficult at this time to include it fully in the many regional initiatives discussed throughout the Report. Nevertheless, FRY is an important and integral part of the region and its inclusion into regional initiatives would provide a boost to development and security throughout the region.

1.13   These countries have been selected as the primary focus of the regional strategy because they are the countries whose economies were the most badly affected by the Kosovo crisis. According to final estimates prepared by the IMF, in consultation with the World Bank: "Despite the quick end to hostilities and resolution of the refugee crisis, the Kosovo crisis was a major setback to the region's economies [Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Federal Republic of Yugoslavia (Serbia and Montenegro), FYR Macedonia and Romania]. The crisis is estimated to have reduced output in the six most affected countries by about 2 percentage points in 1999 and significantly raised budget and current account deficits." This paper also noted that other countries—including Greece, Hungary, Moldova and Ukraine—were affected to a lesser extent. In addition to the Kosovo crisis, the SEE countries are the ones that have been most severely disrupted in the past decade by the conflicts in the former Yugoslavia and by the periodic embargoes imposed on FRY.

1.14   Other countries in the neighborhood of these seven SEE countries are included in the discussion when and where relevant. For example, it is difficult to discuss regional infrastructure without including Hungary, Slovenia, Greece and Turkey. It is also important to note that all countries in the surrounding region are members of the Stability Pact and therefore, many Stability Pact initiatives would include a broader range of countries than those that are the primary focus of this paper.

1.15   Table 1.1 presents a brief picture of the ‘region’. Its total population is 56 million, about 84 percent of the population of the five Central European countries (CEE)5 and 15 percent of the European Union’s population of 375 million. There is a large variation in size: Romania with 22 million people is ten times larger than FYR Macedonia. Total GDP stood at US$100 billion in 1998, only slightly more than one-third of the five CEE countries. It is important to note, however, that in almost all countries official GNP figures are likely to be underestimated, possibly significantly, due to the large informal sectors in these economies. Per capita incomes in the SEE countries also span a wide range from US$4,520 per capita in Croatia—which is roughly equivalent to the CEE average—to US$810 per capita in Albania. The per capita income of FRY—for which there is no official figure—is difficult to estimate. However, prior to the war per capita income was estimated at about US$3,500 and now, it is believed to have fallen to about half this level.

1.16   From this brief snapshot of the SEE region, one can see that the region, as defined in this report, is extremely heterogeneous: alongside its heterogeneity in levels of income and population, there is also heterogeneity in the region’s structural and social development. This heterogeneity poses a major challenge for the design of a regional strategy. In turn, this heterogeneity is reflected in the countries’ differing relationships with European institutions, particularly the EU. Bulgaria and Romania have signed association agreements with the EU and, during the EU Summit in December 1999 in Helsinki, they were invited to begin negotiations for accession. Negotiations for a Stabilization and Association Agreement (SAA) with FYR Macedonia have recently been authorized by the EU.6 Other countries are not yet in an association status with the EU, but are expected to be invited eventually to negotiate SAAs.

Table 1.1: Basic Data: The SEE Region
 

1998 Population
(millions)

1998 GNP
(billions)

GNP
Per capita d

Albania

Bosnia and Herzegovina

Bulgaria

Croatia

FR Yugoslavia

FYR Macedonia

Romania

SEE-7 Total

CEE-5 Total a

SEE-7 as % CEE-5

3.4

4.2

8.2

4.6

10.6

2.0

22.5

55.5

66.4

84%

3.1

4.0

12.5

21.3

17.4 b

3.5

38.1

99.9 c

274.1

36%

810

920

1230

4520

n.a.

1290

1390

2223 e

4329

51% e

a  Countries include: Czech Republic, Hungary, Poland, Slovak Republic, Slovenia.
b  GDP Estimate, Group 17.
c  Includes FRY GDP estimate.
d  World Bank Atlas methodology. Thus, per capita income may not equal exactly US$ GNP divided by population.
e  Excludes FRY.

Source: World Bank staff estimates; EBRD Transition Report, 1999; Group 17, MONEE database.


C.  The Key Components of a Strategy for Peace, Stability and Prosperity in the SEE Region

1.17   As noted in the Stability Pact, a successful strategy for the accelerated development of the South East European region must be built upon a ‘joint’ commitment of both the countries in the region and the Stability Pact partners. Both sides must work in concert to achieve the objectives of the Stability Pact. This ‘joint’ commitment would need to involve the following broad thrusts.

  • For the SEE countries, there needs to be both a strong commitment to working towards political and social stability within the region and a determined effort to implement consistent macroeconomic stabilization policies and deep structural, institutional, social and environmental reforms (e.g., trade, privatization, competition policy and financial sector reforms).

  • For the Stability Pact partners, there needs to be parallel commitments both to providing a clear and credible roadmap for the eventual integration of the SEE countries into European and global structures and to providing financial and technical and political support to domestic reform programs and regional initiatives.

1.18   Without the countries of the region working towards intra-regional peace and stability, it is unlikely that the objectives of the Stability Pact could be achieved. The past decade of transition, nationalism and conflict has left a region fractured economically and socially. This has disrupted the free flow of goods and people, cutting long-standing transit routes and commercial relationships. The lessening of tensions in the region is, therefore, essential to achieving sustainable growth and social and political stability. The lessening of tensions and a rebuilding of trust would allow a gradual de-militarization in the region. This ‘peace’ dividend would free resources to support growth and poverty reduction. The resolution of the large refugee problem in the region could also accompany a lessening of the tensions.

1.19   It is clear that the pursuit of more consistent macroeconomic stabilization programs, and deeper and faster-paced structural reform programs are needed to improve economic performance. These reform programs would yield benefits in terms of economic growth and poverty reduction irrespective of the existence of a ‘regional’ approach. A major factor underlying the poor economic performance of the SEE region, as a whole, is a lack of progress in the transition towards a market-based economy. On almost all indicators of economic reform, the economies of the SEE region have lagged behind the economies of Central Europe and the Baltics. The key objective of these reform programs should be to improve substantially the climate for private sector development, which would need to underpin the achievement of prosperity and sustainable poverty reduction.

1.20   The underlying logic of the Stability Pact is that the efforts of the countries of South Eastern Europe to improve intra-regional cooperation and economic reform would be boosted by the strong support of the international community. This support would have two basic components. First, the international community would provide a clear and credible commitment to the integration of the SEE countries into European and global structures. The second commitment of the Stability Pact partners must be to provide coordinated support, both technical and financial, to the countries of the SEE region. This support should consist of technical assistance for implementing reform programs, strengthening institutions, governance and the rule of law, and (re)building regional infrastructure which would help integrate physically the countries of the SEE region and modernize their infrastructure and services to enable them to compete within the global community.


D.  Sound Domestic Policies—A Necessary Condition for Success

1.21  A necessary condition for achieving the objectives of the Stability Pact is a strong commitment from the SEE countries to work towards achieving peace, stability and more rapid reform. Without such a commitment, no country has achieved sustainable growth and poverty reduction, and no regional approach or initiatives can be effective. Moreover, establishing political stability, the rule of law, fully functioning market economies that can compete efficiently within European markets are essential conditions for accession to the EU. Thus, while the strategy in this paper attempts to lay out a regional framework for the SEE countries and the international community, the regional strategy needs to be underpinned by a country-specific comprehensive development framework for each country.

1.22  The first essential step in achieving prosperity is for the countries of the SEE region to commit to working together for peace, harmony and a full blown reduction of ethnic tensions in the region. There is consistent international evidence that "good neighborhoods"—areas where a sound policy and institutional environment is maintained by a majority of countries—have a powerful influence on the economic success of individual countries. Therefore, country-specific measures to develop ‘good neighborhood policies’ will be crucial. This must include efforts to address presently displaced population groups, including the granting of property rights and to accept existing borders. The current refugee and border situations in the region are a major source of instability and conflict in the region. Key steps in this regard are developing more robust democratic institutions, improving the human rights situation, especially for minorities and refugees, and gradual de-militarization.

1.23  The second important commitment by the countries of the region is to implement more forcefully macroeconomic stabilization and structural reform programs designed to place the economies onto sustainable growth paths. Sustaining macroeconomic stability is crucial to the development of functioning market economies. A balanced and comprehensive approach to structural, institutional, social and environmental reform as envisaged in the Comprehensive Development Framework is also essential to underpin macroeconomic stability and to create an environment conducive to private sector development and investment. This would involve putting in place more transparent and predictable legal and regulatory frameworks, implementing measures to promote small and medium enterprises, strengthening domestic financial systems and their associated regulatory frameworks, and promoting and enhancing the role of the private sector in the provision of infrastructure. Given the importance of agriculture, especially in trade and employment, measures will need to be taken to achieve efficiency gains in the agricultural sector. Reforms to ensure macroeconomic stabilization and structural reform would continue to be supported by IMF and World Bank country programs.

1.24  While stabilization and structural reform programs are by nature country specific, the analysis in Chapter 2 indicates that there are a number of broad areas where progress is required that is common to all the SEE countries (see Box 1.2). There are five areas where policy reform appear to be of a high priority:

  • Private sector development, especially through liberalization of trade, improvement of the business regulatory environment, and strengthening of the financial sector, particularly banking regulation and supervision;

  • Poverty reduction and social development, especially through policies to foster social cohesion and inclusion, including for minorities, refugees and other excluded groups, to encourage democratic and participatory processes, to strengthen social protection, especially for the poor and vulnerable groups, and to ensure adequate access and better performance of social services;

  • Institutional development and governance, especially strengthening public administration, improving financial control mechanisms and improving the legal and judicial systems;

  • Infrastructure policies, especially commercializing and streamlining public utilities, and putting in place a regulatory system that would allow the involvement of the private sector;

  • Environmental policies, especially protecting the region’s valuable natural resources and remedying the consequences of recent conflicts and past inappropriate industrial policies.

Specific discussions about the reform agendas for each of the SEE countries (excluding FRY) are provided in Annex Table 1. Annex Table 2 shows existing bilateral and multilateral agencies supporting the reforms in each priority area.

Box 1.2: Domestic Reform Priorities

I. Private Sector Development/Trade/Finance

Ensure private sector environment conducive to growth, exports and employment.

  • Accelerate privatization and structural reform in the financial and enterprise sector.

  • Develop effective commercial law legal framework.

  • Reduce the tax burden on SMEs, foster development of SME financing vehicles.

  • Alleviate constraints to FDI, including portfolio investment.

  • Eliminate labor market inefficiency, reduce rigidity in labor market legislation.

III. Institutional Development/Government and Public Sector/Corruption.

Maintain a sustainable and growth-promoting macroeconomic framework, reduce the size of the public sector.

  • Identify areas from which the state needs to withdraw and reduce overall level of public spending, ensure spending decisions are based on clear priorities.

  • Define the responsibilities and competencies of government entities and equip them with technology and systems to improve efficiency.

  • Enforce financial discipline, improve resource mobilization by broadening the tax base, improve tax administration and collection, reduce tax rates.

Promote further trade liberalization.

  • Reduce protection through lower, more uniform tariff rates and increase transparency through reducing the number of tariff bands.

  • Eliminate non-tariff trade barriers, through the removal of licenses, quotas and other instruments.

  • Strengthen trade-related institutional capacity.

  • Harmonize existing intra-regional preferences which are not consistent with the WTO.

Reorient state functions to meet the needs of market economy.

  • Adopt and implement effective legal and regulatory frameworks for the operation of private markets.

  • Reorganize state institutions, streamline overlapping and outdated structures.

  • Build local government management capacity and autonomy, strengthen municipalities and enhance devolution of powers to local administrations.

Improve financial system safety, soundness and performance standards.

  • Improve lending policies/practices and risk management of banks.

  • Efficiently manage foreign debt.

  • Improve bank governance through privatization and strengthen supervision of banks and financial institutions.

  • Improve accounting and auditing practices, adopt international accounting standards.

  • Strengthen institutional/market framework, improve technology of financial intermediaries and markets and enhance information transparency.

Enhance state role in long-term development planning, strengthen public administration and database management.

Strengthen the judiciary, enhance judicial implementation capacity, and provide basic resources for judges.

Reduce corruption through identifying areas of public administration most prone to corruption, streamline and rationalize legal and administrative procedures to eliminate corruption encouragement, introduce transparency.

Eliminate distortions in agricultural sector, complete privatization and improve its competitiveness.

IV. Infrastructure.

  • Rehabilitate and strengthen existing infrastructure systems through least-cost investments and reducing infrastructure system losses through improved management.

  • Improve billing and fee collection systems for infrastructure services, insure financial viability of the different sectors, modernize and streamline operations.

  • Open up major infrastructure units to competition, establish legal and regulatory framework for price liberalization.

V. Environmental Management

Improvement of national resource management and environmental standards.

  • Strengthen institutional capacity of the environmental protection institutions at the central (policy issues) and regional (better enforcement and monitoring) levels.

  • Develop or enhance systems for environment monitoring and assessing environmental degradation.

  • Create national strategy for environment priorities and resource management.

II. Poverty Reduction and Social Development.

  • Support poverty reduction and address rising inequality.

  • Promote access to quality education for all children which is suitable for the needs of a market economy, leadership, and democratic society.

  • Reduce inherited inefficiencies in the health sector, through reorienting the health care system to lower levels of care, reforming health finance, updating clinical practices, and facilitating private sector provision.

  • Increase the fiscal sustainability and impact of the social protection system, through reform of pension systems, improving contribution compliance, and targeting social assistance more effectively.

 

 
Source: Country Assistance Strategies for the six SEE countries, World Bank.


1.25   In a number of SEE countries, progress is already being made in implementing key elements of this domestic reform agenda. Albania, Bosnia and Herzegovina, Bulgaria, and Romania all have IMF and World Bank-supported reform programs in place and these programs are reasonably on-track. They involve both macroeconomic stabilization and accompanying structural reforms. Kosovo is receiving substantial technical and financial support from the international community in rebuilding its economy in the aftermath of the recent crisis. In addition, the World Bank is providing a budget support operation and an operation to support the rebuilding of the financial system. There is currently no program in Croatia, but the results of the recent election bodes well for the resumption of an economic reform program that could be supported by the international community. In FYR Macedonia, no IFI programs have been successfully negotiated since the CCFF and the Emergency Credits approved as a consequence of the Kosovo crisis. Implementation of key structural reforms, especially imposing financial discipline on a number of large loss making enterprises, continues to be required prior to the resumption of balance-of-payments and budgetary support. Thus, there is already a good basis for moving forward on regional initiatives and programs in virtually all countries, based on the current implementation of existing reform programs. However, a rapid achievement of the goals of the Stability Pact would require a much deeper, more consistent and longer term commitment to domestic reform than has been experienced to date in the national reform programs. It is essential that the vigor with which these reform programs are implemented be consistent with the deeper engagement that the international community is offering through its support of the Stability Pact.


E.  Integration with European and Global Structures—The Crucial Incentive for Success

1.26   Better cooperation among the SEE states and the pursuit of sound economic policies are, thus, necessary conditions for achieving peace and sustainable economic growth in South Eastern Europe. It is, however, unlikely that individual countries will achieve prosperity if the region as a whole remains unstable and fragmented. An essential element of this regional strategy and an underlying assumption of the Stability Pact are that a credible and predictable path for integration with European and global structures, particularly the European Union, offers both the incentive and the discipline for achieving stability and growth. In addition, a consensus already exists in all countries of the SEE region that EU membership is an overarching political objective. As a consequence, SEE countries are willing to tailor their policies and politics to achieve this objective. In the current situation where intra-regional hostilities, distrust and difficulties have impeded development and the political situation in FRY is uncertain, this external incentive is likely to be one of the main motivating factors for the countries of the SEE region to accelerate the development and implementation of domestic reform programs and to work together towards intra-regional cooperation.

1.27   The influence of such an external target cannot be over-emphasized and is clearly illustrated by recent developments in Europe. First, prospective entry into the European Union can give impetus to reform programs. The prospect of entry into European institutions has helped discipline economic policies in the new democracies of Central Europe and provided a strong incentive for implementing domestic reform programs. In the SEE region, the opening of negotiations on accession with Bulgaria and Romania is providing an important impetus to stability and reform. Second, the prospect of eventual membership can create positive social and political dynamics which can help overcome the deep-seated resentments that have built up during the last ten years of hostilities and wars. Romania and Hungary, for example, have settled border disputes and strengthened minority protections in order to prepare for membership in NATO and the EU. And finally, the prospect of entry into the EU would provide a framework and specific incentives to improve economic management and strengthen political institutions, as well as cooperate more closely. The process of European integration offers examples of successful rapid development by countries that were characterized by nascent democratic systems, fragile macroeconomic situations, and little intra-regional integration.7

1.28   There have also been considerable empirical analyses of the benefits of regional integration agreements (see Box 1.3). These analyses are based on integration initiatives in Europe, as well as trade and regional integration agreements in Latin America, East Asia and Africa. One key finding is that regional integration agreements can lead to improved credibility in policies:

 

Box 1.3: Regional Integration Arrangements Economic and Political Implications

 The World Bank held a symposium on regionalism and development, based on the findings of the Development Economics Research Group’s research program on regionalism and development. The aim of the symposium was to advance the debate on Regional Integration Arrangements (RIAs) by subjecting existing arguments to rigorous theoretical analysis and empirical testing. Papers from the symposium were published in the May 1998 edition of The World Bank Economic Review.

The findings of the symposium contain important results that are relevant to the formulation of a regional strategy for integration in the South Eastern European region:

  • On growth and industrialization, a paper by Vamvakidis finds that open economies grow faster; economies that have open and large neighbors grow faster, but the size of closed neighboring economies is of no account; and, economies that have open and developed neighbors also grow faster, but again the level of development of closed neighboring economies is not important. One key finding is that countries benefit from being located close to large, developed open economies. He also finds that agreements between small, closed developing countries are unlikely to have a positive impact on growth. Research by Fernández and Portes's and Puga and Venables's also support these conclusions; their results clearly suggest the advantages of North-South [i.e., between developed and developing countries] RIAS over South-South [i.e., among developing countries only] ones. In conclusion this research clearly demonstrates that: (i) RIAs may boost the industrialization efforts of a developing member but retard those of an excluded developing country; and (ii) countries may derive growth benefits from being a neighbor to a large, developed, open economy, but RIAs between developing countries are unlikely to result in faster growth.

  • On credibility, Fernández and Portes analyze the economic mechanisms through which a developing-country member may gain policy credibility that is not obtainable unilaterally or multilaterally. Their results show that regional trade agreements can serve a useful purpose above and beyond the direct gains from trade liberalization by reducing uncertainties about national policies or political developments and enhancing credibility. This increased credibility, in turn, makes it easier for the private sector to plan and invest. Schiff and Winters's research contains a dimension about the credibility effects of solving the political problems caused by conflict between two neighboring countries. Vamvakidis's conclusions on the benefits of desirable neighbors relate to credibility changes considering the geographical spillover effects of recent crises, in particular the "tequila effect" in South America or the recent "Asian flu".

Combining these results suggests the possibility of virtuous and vicious circles in RIA formation. A strong, liberalizing RIA with the right partner may lead to a virtuous circle of increased credibility, increased investment and growth, more credibility and political stability, and so on. By contrast, a more-closed agreement or wrong choice of partner could lead in the opposite direction, with reduced credibility and lower investment and growth, resulting in less credibility and more political instability over time.

Source: Abstracted from "Dynamics and Politics in Regional Integration Arrangements: An Introduction", Maurice Schiff and L. Alan Winters, The World Bank Economic Review, Vol. 12, No. 2, May 1998, pp. 177–196.


"Attempts at reform are often undermined by expectations of reversal. A regional agreement can provide a 'commitment mechanism' for trade and other policy reform measures: a way of raising the cost, and thereby reducing the likelihood, of policy reversal. This argument can apply to political as well as economic reform, and there are examples where regional agreements have reinforced democracy in member states."8

1.29   Another key finding is that small economies can obtain significant benefits—in terms of higher growth and investment—from regional integration agreements with large and open economies. On the other hand, agreements between small closed economies do not tend to have a significant growth impact.

1.30   The above indicates that the success of the Stability Pact would be greatly enhanced by the establishment of a firm and credible roadmap to the integration of the SEE countries into European and global structures.

1.31   Bulgaria and Romania were invited for formal accession negotiations in Helsinki in December 1999. For the other countries of the region, at the Heads of State and Government of the EU meeting on June 4, 1999, the Cologne European Council reaffirmed the readiness of the European Union to:

"draw the countries of this region closer to the prospect of full integration into its structures. This will be done through a new kind of contractual relationship taking into account the individual situations of each country, including progress in regional cooperation, and with the perspective of European Union membership, on the basis of the Amsterdam Treaty and fulfillment of the criteria defined at the Copenhagen European Council in June 1993." (Para. 72 of the Presidency conclusions of the Cologne European Council).

This commitment is also reflected in the Stability Pact.

1.32   The importance of the integration of the SEE countries into Europe was also echoed in Mr. Prodi’s recent statement on enlargement: "In the longer term the EU can best contribute to stability in the region [South Eastern Europe] by drawing it closer to the perspective of full integration into its structures, and should confirm that the countries of the former Yugoslavia and Albania have the ultimate vocation to become members of the European Union."9

1.33   The roadmap for intra- and inter-regional integration will depend on the content of these proposed new avenues for association and eventual membership in the EU. The European Commission has offered a generic direction in its Communication to the Council and European Parliament on the Stabilization and Association Process for countries of South Eastern Europe.10 The Stabilization and Association process has advanced with the adoption of negotiating directives for a SAA with FYR Macedonia and a review of the feasibility of opening negotiations with Albania (see Box 1.4). While this approach establishes a broad framework applicable to all SEE countries which are not yet associated through an Europe Agreement and is conducive to inter- and intra-regional integration, there are two risks with it. The first is that some countries will perceive themselves as remaining for some time de facto excluded, possibly leading to more not less fragmentation of the region. The second risk is that for some countries the perspective of joining the EU would appear to require a time horizon so long that it would not unleash the political and economic dynamics necessary to create the preconditions for stability and economic cooperation among countries in the SEE region. The integration perspective of SEE countries needs to be a "real perspective" which is of relevance for today’s political leaders and populations.11 A highly differentiated path to EU accession could well fuel nationalistic sentiments and hostilities caused by those countries which feel left behind.

1.34   Overcoming these risks would require an approach which would allow the SEE countries to move towards the EU according to common rules set within a realistically achievable timeframe. Such an approach would have a strong disciplinary effect on the countries and would provide an important anchor for stability. Such a common approach would be in line with the approach taken by the European Council with respect to the CEE-enlargement countries.

Box 1.4: Stabilisation and Association Agreements

The Stabilization and Association process is based on political and economic conditionality as established by the Council on 29 April 1997. Compliance with this conditionality forms the basis for the development of the relations of the EU with these countries in the field of trade (eligibility for autonomous trade preferences), financial and economic assistance and contractual relations. At present, there are contractual relations, in the form of Cooperation Agreements with two of the five countries—the former Yugoslav Republic of Macedonia and Albania. The new kind of agreements mentioned above—the Stabilisation & Association Agreements—for which Bosnia and Herzegovina, Croatia, the Federal Republic of Yugoslavia (Serbia and Montenegro), the former Yugoslav Republic of Macedonia and Albania are eligible as the conditions will be met are intended to govern the political, economic and trade relations between the parties.

At the last review of conditions in Spring 1999, the European Union considered that the former Yugoslav Republic of Macedonia and Albania met the political and economic conditions for a more in depth examination of the feasibility of opening negotiations on a Stabilisation and Association Agreement. The Commission has reported on the feasibility of the opening of such negotiations in the case of the former Yugoslav Republic of Macedonia. The Commission then adopted on 8 September 1999 its recommendation to the Council for negotiating directives. Its essential elements are:

  • the inclusion in the Agreement of dispositions establishing a political dialogue with the former Yugoslav Republic of Macedonia;

  • provisions on enhanced regional cooperation, including the perspective of establishing free trade areas between the countries of the region;

  • the establishment of a free-trade area between the EU and the FRYOM within ten years after the entry into force of the Agreement; dismantling of tariffs will be asymmetric. It shall be noted that under present Cooperation agreement almost all industrial products enjoy duty free access to the EC market;

  • provisions on the movement of workers, freedom of establishment, supply of services, current payments and movement of capital;

  • the commitment by the former Yugoslav Republic of Macedonia to approximate its legislation with that of the EC, notably in key areas of the internal market;

  • provisions on cooperation with the former Yugoslav Republic of Macedonia in a wide range of fields, including justice and home affairs.

This led to the adoption of negotiating directives for a Stabilisation & Association Agreement with the former Yugoslav Republic of Macedonia by the General Affairs Council on 24 January 2000. Formal negotiations could start at the end of March 2000. After signature, entry into force will have to wait for ratification by the Member States’ Parliaments (which, according to past experience, may last for up to three years). However, trade provisions which are under Community competence and therefore not subject to ratification by Member States Parliaments might enter into force more rapidly through the conclusion of an interim agreement. In the case of Albania, the Commission concluded that further examination was needed before entering into the negotiating process, in particular due to institutional weakness of this country. The readiness of the Union to assist Albania in overcoming these weaknesses was reaffirmed.

Source: DG RELEX, European Commission.


F.  Roadmap and Brief Overview of the Report

1.35   The remainder of this paper supports the regional strategy by analyzing the ‘initial’ conditions in the SEE countries and proposing a series of interventions designed to support the achievement of regional prosperity, peace and stability. These interventions involve three types of initiatives (i) national reform programs and priorities; (ii) initiatives that foster intra-regional integration or cooperation; and, (iii) initiatives that involve integration with European and global structures. At the outset, it is useful to define the scope of the initiatives discussed in this Report. The Report focuses on those sectors where significant synergies can be achieved by coordinated initiatives, which build upon, but do not substitute for, national programs. So, frequently the Report discusses national programs when their implementation is essential for a regional approach to be effective. The national programs that have been included, however, are selective and are only referred to as they are considered to be relevant for their regional dimensions. Therefore, many important elements of national agendas, which are considered to be of overriding importance for achieving sustainable economic development—for example provision of health services, municipal services, social protection systems, agricultural extension and research—which a priori are less immediately relevant from a regional integration perspective, have not been explored. Such programs, however, would be essential elements in the design of a comprehensive development framework for each country.

1.36   Chapter 2 provides an analysis of recent economic developments, and trends in living standards. From this analysis, it is clear that the past decade of transition and conflict has left the region with a legacy of mediocre growth and declining living standards. Calculations show that the region has recovered only about 75 percent of pre-transition GNP. The Chapter also shows that there has been a deterioration in living standards in the region, as evidenced by higher poverty, inequality and unemployment. The Chapter concludes with an analysis of progress on economic reform in the SEE region. It notes that, while good progress has been made in achieving macroeconomic stability, progress on structural reform and institutional development has lagged, especially when compared to the economies of Central Europe and the Baltics. Thus, the gains on macroeconomic stability are fragile and the prospects for these economies to move onto a sustainable growth path are not good without deeper reforms, a strengthening of institutions and governance and measures to reduce poverty.

1.37   The subsequent Chapters each discuss important elements of the regional strategy and outline initiatives that would support achievement of regional integration and development. First, the Report discusses regional initiatives to enhance the environment for private sector development as a way of accelerating and magnifying the impact of more determined implementation of reform programs and of the credible commitment to broader regional integration. The first concrete step in reaching eventual integration into European and global structures would be trade integration. Trading relationships have generally preceded other integrative steps as in Bulgaria and Romania and an opening of trade for the other SEE economies would also provide a badly needed stimulus to investment and economic growth. Trade integration and reform is discussed in detail in Chapter 3.

1.38   There would be scope for a number of regional initiatives to improve the investment climate for the private sector and to support small and medium enterprise development. The goal of these initiatives would be to help create a vibrant private sector that exchanged goods and invested freely across borders. The stimulus of growth and investment will come from the creation of new small business and foreign investments, from market expansion and from building an efficient private and public infrastructure. The perspective of closer integration of the region into Transatlantic and European structures is expected to help mobilize resources for change, raise investor interest and build confidence in the future stability of the business environment. Initiatives in these areas are discussed in Chapter 4.

1.39   Special efforts are also needed to include more fully and effectively all population groups in the economic development of the region, including minority groups living in different countries (such as Serbs in Croatia, Albanians and other minority groupings in FYR Macedonia, Serbs in Kosovo, Hungarians in Romania, and Turks in Bulgaria). Given the region’s ethnic mixture, these issues are particularly sensitive. A regional approach is essential in this regard, because displaced minority populations contribute to the continued tensions in the region, and the lack of a satisfactory solution is a major obstacle to peace, stability and economic development. Displaced minority populations for example in Bosnia and Herzegovina and FRY (both from Kosovo and Croatia) lack access to their assets and have a limited ability to plan and invest on a longer term basis. Increased efforts will need to be made to protect vulnerable groups from falling into poverty. Continued increases and persistence of poverty among certain population groups could further increase fragmentation of the already divided societies in South Eastern Europe. Access for all people to public services and employment opportunities, and a minimum level of income support when in need, should be provided. Special efforts need to be made to reach out to the Roma community, which lives in poverty in many countries in the region. There is also a special role for education in creating leadership, value changes and human capital that will be essential not only for national economic development but also regional cooperation. The important role which future generations of leaders will play requires a special focus on employment creation and social programs for the young, to avoid the marginalization of those disconnected from schooling and formal labor markets. Issues of social cohesion and inclusion are discussed in Chapter 5.

1.40   Sustaining sound policy environments and meeting the institutional requirements for a more formal association with European and global structures will require a quantum leap in institutional development in the SEE countries. The importance that institutions play in assuring that competitive markets function efficiently is now widely recognized. Most transition economies have experienced costly setbacks in their development due to inadequate institutional development. The SEE economies are no exception. They currently have important weaknesses in most public service functions, including public policy formulation, public service delivery and oversight and accountability. They need to work towards improving governance, by instituting systems with adequate checks and balances that provide politicians, bureaucrats and economic agents the incentives and flexibility to pursue the common good. Institutions need to represent all segments of society. The agenda is large and includes: greater transparency and accountability in the functioning of state institutions, better internal controls (e.g., strengthened financial management in sectoral ministries, audits, procurement, watchdog bodies), a reduction in administrative discretion (price liberalization, elimination of excessive licenses), and greater participation and oversight from users and civil society.

1.41   Special attention will need to be given to combating corruption. The economic costs of corruption are well documented.12 Corruption impedes the development of markets. The transaction costs, risks and problems of credibility generated in corrupt systems limit substantially the interests of investors in the region. There is ample evidence that corruption reduces investment and growth. A Business Environment and Enterprise Performance Survey commissioned by EBRD details that more than in any other region, Small- and Medium-size Enterprises (SME) in Southeast Europe report corruption as an important obstacle to business development. Therefore, if SMEs are to be an engine of growth and employment, a frontal attack on corruption is essential. Regional initiatives for supporting institutional development and combating corruption are discussed in detail in Chapter 6.

1.42   Economic growth, improved intra- and inter-regional trade and integration will depend on incremental and efficient investments in infrastructure. Wars and conflicts which erupted in large parts of former Yugoslavia resulted in considerable damage to infrastructure. The period of unrest and economic decline during the 1990s led to a serious deterioration of maintenance of infrastructure, as declining incomes and tax revenues curtailed maintenance activities. Lack of reforms did not support the shift from public budget based to user-based cost recovery mechanisms, and most of the burden of infrastructure maintenance continues to rest on the public sector. A key element affecting the transport links of the region is the interruption of Danube shipping. The economic consequences of the damages resulting in the interruption of key transport routes are severe as the destruction of a series of bridges across the Danube prohibits long distance shipping. The financing needs in infrastructure are particularly large and adequate funding will be difficult to raise from traditional methods. Thus, there is also a need for more private sector involvement in this area. By implication, this suggests that a substantial effort will also need to be made to put in place a transparent and predictable regulatory framework. Infrastructure is discussed in Chapter 7.

1.43   The Yugoslav war and recent hostilities in Kosovo have damaged the environment in several SEE countries. The Danube has been seriously affected; water quality has badly deteriorated through the emission of effluents resulting from destruction of industries, oil refineries, and wastewater treatment facilities. Environmental damages are also expected in SEE countries located along the Danube from flooding and debris which is caused by the Danube blocked by destroyed bridges. Other war related damages result from land mines placed in most of the war affected areas which have not yet been removed, pollution of water bodies, bombing of cultural heritage sites and damages to coastlines and tourism sites. The wars, civil disturbances and economic declines also in some countries led to breakdown or deterioration of environmental services. Regional initiatives to address existing environmental concerns are discussed in Chapter 8.

1.44   It is important to note that growth prospects for the region will depend critically on restoring and maintaining security. As long as the dangers of war and fragile domestic security situations exist, it is highly unlikely that sustainable development can be achieved. This regional strategy does not discuss this point in detail or elaborate on specific initiatives in this area. But, regional cooperation, integration and development will not reach their full potential until specific actions are taken to increase domestic security and limit illegal activities and crime. Detailed security programs to be established for the region are being developed under the Working Table on Security Issues within the Stability Pact framework.

1.45   In conclusion, this Report should be viewed as setting the broad framework for the international community’s response to the need to support regional development in South Eastern Europe as articulated in the Stability Pact. Our other development partners are working within this framework to develop further specific initiatives to support regional development. In particular, the EBRD has the lead role in preparing initiatives in the area of private sector development. The EIB has the lead role in developing and assessing projects in the infrastructure sector that could be supported by donors. Finally, a number of other agencies are preparing individual initiatives that are mentioned throughout the Report.
1   "Time for Enlargement," Hans van den Broek, Chapter 5 in The Second Decade: Prospects for European Integration after Ten Years of Transition, Sdu Publishers, The Hague, 1999, p. 99.

2   See James D. Wolfensohn, A Proposal for Comprehensive Development Framework, World Bank, January 21, 1999.

3   The beneficial effects of EU membership on democratic consolidation and economic development has been amply demonstrated for Greece, Spain, Portugal. Possible lock-in effects, an acceleration of economic reforms, as well as social inclusion and participatory processes have also all been observed in the CEE countries destined to join the EU as member states. See G. Richard; Diamandouros, P. N., H.-J. Puhle: The Politics of Democratic Consolidation: Southern Europe in Comparative Perspective, The Johns Hopkins University Press, 1995; Baldwin, R.E, Francois J.F., Portes, R., The Costs and Benefits of Eastern Enlargement: The Impact on the EU and Central Europe, Economic Policy, April 1997.

4   Moldova, which participates in the Stability Pact as an observer, shares social, economic and cultural characteristics with the region.

5   Poland, Hungary, Czech Republic, Slovenia and Slovak Republic.

6   European Commission, Commission Communication to the Council and European Parliament on the Stabilization and Association process for countries of South Eastern Europe, Brussels, May 26, 1999, COM (99) 235.

7   See, "A European ‘New Deal’ for the Balkans", Benn Steil and Susan L. Woodward, Foreign Affairs, November/December 1999, Vol. 78, No. 6, pp. 95 – 105.

8   See Trade Blocs and Beyond: Political Dreams and Practical Decisions, SecM99-809, The World Bank, December 23, 1999, p. 4.

9   See "The Composite Paper: Reports on Progress Towards Accession by Each of the Candidate Countries", 1999, The European Union, p. 37.

10   European Commission, Commission Communication to the Council and European Parliament on the Stabilization and Association Process for Countries of South Eastern Europe, Brussels, May 26, 1999, COM (99) 235.

11   The importance of a real perspective for EU membership is reflected in the discussions of the European Parliament in the Commission Recommendation for a Council Decision authorizing the Commission to negotiate a SAA with FRY Macedonia. The draft report states: "It must be made clear in the Stabilisation and Association Agreement that it is an instrument which can quite well lead in the long term to EU membership. It should, therefore, include an evolutionary clause describing the route from association to membership." See European Parliament, Draft Report, December 9, 1999, Provisional 1999/2121 (COS).

12   Among the large literature see among other Paolo Mauro, "Corruption and Growth", Quarterly Journal of Economics, August 1995, p. 695; Shan-Jen Wei, "Why is Corruption so Much More Taxing than Tax Arbitrariness", NBER Working Paper 6255, November, 1997.

Table of Contents | Next-> Chapter 2: Economic and Social Developments and Progress on Reform in South Eastern Europe

The Road to Stability and Prosperity in South Eastern Europe is also available in PDF format (850 KB)

Top | Home | Search | Site Map | Contact