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

Chapter 2: Economic and Social Developments and Progress on Reform in South Eastern Europe

2.1   The transition has been generally disappointing for the countries in South Eastern Europe. Growth has yet to recover to pre-transition levels. Some countries still face problems of macroeconomic stabilization and in others, stability is still fragile and subject to reversals. These problems have been especially pronounced over the past three years, when a number of countries have experienced bouts of macroeconomic instability. None of the countries have yet established a firm foundation for sustainable growth and progress on improving living standards has also been disappointing.

2.2   This chapter takes a broad overview on the past "decade of transition and conflict" in the SEE region. First, it analyzes the region’s growth and macroeconomic performance (Section B). Next, the chapter discusses progress on improving living standards (Section C). Finally, the chapter examines progress on structural reform in the region, also comparing progress in key reform areas with what has been achieved in the five Central European economies (Section D). The last section concludes.

B.  Recent Economic Performance

2.3   Historically, South Eastern Europe has been the least developed region of Europe. Initial conditions at the onset of the transition process were less favorable than those in other transition countries in Europe. The SEE countries had more unbalanced industrial structures. They lacked traditions in institutional development. Some countries inherited large debt burdens. And finally, distances to western European markets were great and transport links were not well established.

2.4   Poor initial conditions have combined with conflict and uneven implementation of reform programs to yield a relatively poor economic performance since the onset of the transition. Progress in achieving macroeconomic stability has been good recently, but remains tenuous and subject to reversals. While the five economies of Central Europe were able to stabilize the macroeconomic situation largely by the mid-1990s, most of the SEE countries have struggled with establishing macroeconomic stability late in the 1990s (see Annexes 2.1-2.8). Albania, Bulgaria and Romania have suffered severe bouts of macroeconomic instability in the last three years. Recently, good progress has been achieved on improving the macroeconomic situation in Albania (through fiscal tightening and a reduction in domestic financing of the budget deficit) and in Bulgaria (with the introduction of a currency board). Romania has also made progress, although inflation remains high and a substantial degree of macroeconomic uncertainty remains. FRY also continues to suffer from extreme exchange rate instability and very high inflation. The progress achieved throughout the SEE region during 1999 is remarkable, given the uncertainty and economic pressures felt in the region as a result of the Kosovo crisis. The gains in macroeconomic stability have been achieved through the implementation of consistent monetary and fiscal policies along with supporting exchange rate regimes in most cases with reform programs supported by the IMF and the World Bank.

2.5   Nevertheless, the fiscal situations remain clouded with uncertainty in nearly all of the SEE countries, which could pose difficulties for the implementation of the regional strategy outlined in this Report. First, taxes on international trade are important sources of revenues in the SEE region. For 1998 and 1999, international trade taxes accounted in each year for about 3 percent of GDP. In some cases it is higher; in Bosnia and Herzegovina, they account for about 10 percent of GDP; and in FRY Macedonia, they account for about 4 percent of GDP. Thus, if a significant liberalization of trade occurs as part of the SEE region’s integration with itself and European and global structures, alternative sources of revenues may be needed to sustain the progress already achieved in improving fiscal management. These revenue losses could be offset, to some extent, however, by higher trade volumes and improvements in collection efficiency. Second, the past decade and the reestablishment of macroeconomic stability in most countries of the region has already resulted in a compression of fiscal expenditures, which has been exacerbated by the need to accommodate the cost of structural reforms. In many cases, social sector expenditures have borne the brunt of this fiscal adjustment. This has been one factor underlying the observed decline in health and education indicators and the lower living standards of pensioners. To foster the social cohesion necessary to underpin the objectives of peace and stability, adequate resources will be needed for social expenditures. One key area for further fiscal contraction to accommodate a higher level of expenditures in other vital categories is military demobilization or the ‘realization of a peace dividend’ which should be possible given the enhanced security situation as the SEE countries move towards closer integration. In summary, macroeconomic gains are still vulnerable to reversals because of the difficulties of sustaining existing fiscal positions and the further pressures on fiscal policy that could emerge. This macroeconomic uncertainty still clouds the environment for growth and investment in nearly all the SEE economies.

2.6   While recent gains in macroeconomic management are encouraging, economic growth has been and remains disappointing.¹³ The transition recession in the Central European economies lasted for some three to four years, and the decline in output was about 15 percent of the 1989 output level on average. In contrast, in South Eastern Europe, the decline was greater, the recovery slower and more recently, aggregate GDP has begun to fall again (see Chart 2.1). The cumulative decline in output was about 30 percent of the 1989 output level. As a group, the SEE economies have contracted by more than one percent per annum, since 1989 (see Table 2.1). In comparison, the five economies of CEE grew by almost 1 percent per year. The six SEE economies have only reached 75 percent of their pre-transition (1989) levels of economic activity. This can be compared to the five Central European countries, which on the backs of more resolute and coherent reform programs and more stable political conditions, have grown by nearly one percent per annum on average. As a result, the CEE economies are now nearly 10 percent larger than their pre-transition levels. A worrying trend is that the SEE economies have experienced increasing divergence with western Europe. Per capita GDP (on a purchasing power parity basis) drifted from 33 percent of the EU average in 1990 to 24 percent in 1998.

2.7   While growth has resumed in some SEE economies at the end of the 1990s, it continues to look fragile, as most countries have failed to experience sustained increases in productivity. In all transition countries in Europe, productivity declines were experienced early in the transition. Developments in productivity were dominated by the decline in output, as many firms initially avoided large-scale layoffs even though demand for their products had collapsed. This decline in measured productivity began to be reversed in most countries after two or three years—primarily due to further employment reductions. More recently, some of the Central European countries have entered a phase of productivity growth, driven by product innovation, fresh capital investment, improved technologies and modern management methods (that is, by deep restructuring). Many Central European countries exhibit a J-curve pattern for labor productivity, with especially rapid increases in Hungary and Poland. In contrast, productivity growth in the South Eastern Europe has generally stagnated. Whereas CEE's productivity in 1998 was almost one-and-a-half times as high as the 1989 level, in the SEE economies it only reached about 90 percent of its 1989 level (see Chart 2.2). Deeper enterprise restructuring and new investment will be needed to sustain productivity improvements achieved primarily through the shedding of jobs during the early years of the transition.

2.8   A key factor underlying the poor growth and productivity performance of the SEE region has been inadequate investment. The investment-to-GDP ratio in the SEE region (excluding Bosnia and Herzegovina) has declined from 23 percent of GDP in 1992 to only 18 percent of GDP in 1998 (see Table 2.2). Investment levels in recent years have been particularly low (less than 20 percent of GDP) in Albania, Bulgaria, and Romania. All three countries have experienced bouts of macroeconomic instability recently, which have depressed investment levels. By comparison, the average investment-to-GDP ratio in the more rapidly growing CEE economies has increased from 19 percent of GDP in 1992 to 28 percent in 1998. As noted above, investment has been a driving force behind the productivity gains experienced in the five CEE economies.

2.9   While investment levels overall have been lower in the SEE countries than the CEE countries, foreign direct investment (FDI) as a percentage of GDP has been roughly the same or only slightly less in the SEE economies. This indicates that higher domestic investment levels will be the key to improving the SEE region’s growth prospects. It is important to note, however, that the growth impetus flowing from FDI in the SEE economies has been less, as the efficiency of FDI inflows in the SEE region has been diminished by the weaker reform effort. Thus, a strengthening of the reform effort will likely induce both higher levels of investment, as well as improved investment efficiency.

2.10   Low savings rates are a major constraint on economic development in the SEE region (See Table 2.2). The effect of improved fiscal management is apparent in the increase in government savings. But, the low level of non-government savings (which includes state-owned enterprises) has been a key constraint. As a consequence, foreign savings (the inverse of the current account deficit) has financed about one third of gross domestic investment. Achieving the levels of investment necessary to support sustained and higher economic growth will require higher levels of domestic savings as the high level of past foreign savings has added to the region’s debt burden. Overall, the SEE region has a debt/GDP ratio of 40 percent and a debt service ratio of over 20 percent in 1999 (see Annex Table 2.8). While the debt service ratio was uncharacteristically high in 1999, primarily due to a bunching of repayments in Romania, the debt burden implies that the SEE countries need to carefully manage their external imbalances. As a consequence, the international community and the SEE countries need to examine carefully the terms, conditions and overall levels of external borrowings in the medium term, as well as the financial viability of any projects.

2.11   As with most transition countries, the SEE countries inherited and largely continue to have social indicators which are significantly better than countries of similar income levels in other parts of the world. Nonetheless, the heterogeneity of the SEE region is also reflected in variations in living standards and social indicators between countries (see Table 2.3). The contrast between Croatia—which ranks 55^th in the world on the UNDP's Human Development Index and has almost an OECD-level infant mortality rate- and Albania or Kosovo is stark. This section examines in depth the evolution of living standards in the SEE region during the 1990s, as improving dramatically human welfare in the SEE region lies at the heart of the objectives of the Stability Pact.

2.12   The poor economic performance and regional conflicts during the past decade have taken their toll on living standards within the SEE region, as they have sharply declined during the 1990s. Employment and wages trends provide one indication of this trend. Real wages have declined throughout the 1990s in the SEE countries, whereas in the five Central European economies they fell less in the initial transition period and have risen above their 1990 level by 1997.

2.13   In addition to the deteriorating position of those in wage employment, a large pool of unemployed emerged in most SEE countries. Registered unemployment in several SEE countries was easily the highest in the entire ECA region (see Table 2.3). Registered unemployment had reached 36 percent and 30 percent in FYR Macedonia and FR Yugoslavia, respectively. Estimates of combined registered and unregistered unemployment in Bosnia and Herzegovina are over 55 percent for 1998. While unemployment data in transition economies need to be treated with caution, as many registered unemployed work in the informal economy, this is offset partly by the non-registration of the genuinely unemployed, and removal of people from the unemployment roles upon exhaustion of benefits. Unemployment rates are therefore reasonable indicators of the general declines in living conditions, particularly as the unemployed have been found to have amongst the highest poverty rates in SEE countries. While it is important to note that the five Central European economies also experienced high persistent unemployment, the rate has broadly stabilized since the mid-1990s at a significantly lower level than in most SEE countries.

2.14   Data on poverty are more difficult to obtain and trends are therefore, difficult to discern. Despite these data difficulties, country-specific analyses reveal several consistent findings about the features of poverty in the SEE region (see Box 2.1). The limited reliable time series data that are available from individual countries show that poverty is likely to have worsened dramatically in recent years. In Bulgaria, the poverty survey found that the headcount rate increased by around seven times between 1995 and 1997, but there may be comparability issues arising from the dramatic increase in prices in 1997. In Romania, the poverty headcount increased fivefold between 1989 and 1998. The dramatic drop in the overall consumption level has been the main driver of increased poverty, with increased inequality a lesser but quite important factor, and probably increasing in importance as time passes.

2.15   The evidence also suggests that inequality has increased significantly in the region over the decade. It is important to note, however, that artificially compressed wages and more limited returns to education in the socialist period made some increase in inequality during transition highly likely. The Gini coefficient—the most common inequality measure—has deteriorated significantly (e.g., Romania, Bulgaria and FYR Macedonia) and the same is true for other measures, such as the decile ratio, which focuses on the extremes of the distribution:

• Inequality in Bulgaria increased sharply between 1995 and 1997, with the Gini rising from 27.1 to 31.4.
• In FYR Macedonia, the Gini rose from under 20 in 1993 to almost 30 in 1996.
• Romania experienced an increase in the Gini from 21 in 1989 to 30 in 1994. Recent work by the World Bank finds a Gini for expenditures of 30 in 1998.
• In Croatia, there also appears to have been a deterioration in inequality. The Gini for expenditures is estimated at 32 for 1998.
• Although no reliable time series data are available, Bosnia and Herzegovina would appear to have among the highest income inequality, but there are significant shortcomings in the data.

2.16   There is clearly a cause for concern if such trends continue. At the same time, SEE countries started with low inequality, at least some of the increase should be seen as a reflection of increasing returns to skills in the labor market. With the exception of BiH and Romania, even the higher percentages place the SEE countries in a normal range for OECD countries. However, this would soon cease to be the case if trends during the 1990s continue. In addition, if one takes CEE as the relevant comparator, inequality levels in SEE by the mid-1990s were already high, with a CEE average Gini for earnings of 30 in 1997. Finally, close attention needs to be paid to measures of poverty such as the decile ratio which focus on the extremes of the distribution, to monitor the share of income accruing at the very top of the distribution, as such glaring inequalities can become a source of social instability.

2.17   It is important to examine human welfare and living standards in the SEE region from perspectives other than income and expenditures. One important factor that has adversely affected living standards in the SEE region is the large population movements that have been the result of the conflicts in the former Yugoslav republics.¹⁴ This is a special feature of the SEE region during the transition period. Estimates indicate that some three million people have been displaced either temporarily as was the case during the Kosovo conflict or on a longer term basis, such as ethnic groups in the minority in particular areas, for example in Bosnia and Herzegovina, and Croatia. These displaced persons have been separated from their assets, e.g., housing and land, and from their sources of employment. In many cases, their assets were destroyed. The loss of assets, as well as the social and psychological impact of physical dislocation, has resulted in substantially lower living standards for significant numbers of people in the region.

2.18   Basic services and infrastructure, such as education, health, water supply, sanitation and roads, provide another measure of living standards. Diminished access or quality is likely to show up with a lag, as labor market outcomes deteriorate or the longer term impact of inadequate health care systems shows in morbidity and other health indicators. The distribution of services and infrastructure also matter, as they tend to be unequally distributed within the SEE countries, which adversely affects the poor.

2.19   The demographic structures of the SEE countries are quite heterogeneous: a mix of typical CEE old age structures, alongside regional outliers like Albania and Kosovo, which have the largest share of young in their populations and the highest fertility rates in Europe. In terms of demographic dynamics, the SEE region has experienced substantial declines in total fertility rates (TFR) during the 1990s, a phenomenon which is typical of transition economies (see Chart 2.4). However, it is also important to note that declines in TFR were just as dramatic in the 1980s in most SEE countries. The trends suggest that fertility decline is as at least partly the usual downward movement of such rates over time, and not solely a large fertility response to economic shock.

Chart 2.4: Total Fertility Rates, 1980-97, SEE and CEE/CIS

Note: (a) Bulgaria, Croatia and Romania 1998; CEE/CIS 1995, excludes C. Asia. Source: Transmonee Report, UNICEF (1999).

2.20   The evolution of life expectancy—particularly male life expectancy—has been dramatically downwards in several transition countries in Europe and the CIS. In contrast, the picture in SEE countries during the 1990s is one of stagnation or slight decline for males, and slight increases for females. Overall, SEE male life expectancy fell from 68.6 to 68.2 years, and female life expectancy increased from 74.5 to 74.7 between 1990 and 1997. However, the aggregate picture masks differences between Albania and Bulgaria—where both male and female life expectancy declined—and FR Yugoslavia and FYR Macedonia, where life expectancy for both increased over the period. This mixed and rather static position contrasts sharply with the 1980s, when the average SEE male life expectancy increased by one year, and female life expectancy by 1.7 years.

2.21   The evolution of health indicators also gives some indication of the progress that has been achieved in living standards throughout the region. While basic health indicators have in most cases been sustained, they are worse than regional averages, and systemic problems raise serious questions as to whether current indicators can be sustained in the future. Mortality rates tell the story nicely (see Tables 2.4 and 2.5): they are very favorable by developing country standards (which is characteristic of transition economies), but they remain high compared to the neighboring CEE economies and they are being reduced more slowly. This also must reflect the fiscal pressures that these countries have undergone in the past decade and the fact that the social sectors have not been immune to the fiscal contraction. It is also important to note that a simple examination of status indicators can give quite a misleading picture of the evolution of access to quality care for the population, in particular the poor population. In fact, access to social services is unequal in most SEE countries.¹⁵ It is also important to note that health outcomes are products not only of the health care system, but of a range of other factors, including housing, female education, and water and sanitation.

2.22   Living standards in the SEE region have also been adversely affected by the deterioration in the environment over the past several decades.¹⁶ First, the industrialization of the SEE countries during the socialist period was accomplished with little consideration for the impact on the environment. Second, the past decade of transition and conflict also weakened institutions, put additional pressures on the natural resource base as living standards have stagnated, and ruined or severely damaged/degraded specific areas, particularly as a result of armed conflicts. Furthermore, war damage to industrial facilities has created a number of environmental hot spots, which have especially damaged water and soil resources. The poor and lower income groups are especially vulnerable to environmental degradation, as they depend to a larger extent on natural resources for their livelihood, use more fragile water sources and may live in closer proximity to degraded areas. Thus, the deterioration in the environment of the SEE region has been another factor in declining living standards of the people of the SEE region, even if the impact is difficult to quantify.

D.  Progress on Economic Reform

2.23   The underlying reasons for the poor economic performance of these six economies stem primarily from three sources. First, as noted above, these economies started the transition from very weak positions—political uncertainty was high, institutions were weak, and civil societies were fragmented. Political uncertainty was high even in those countries, which were not former Yugoslav republics. Albania, Bulgaria and Romania have all faced, in the past several years, political uncertainties that have severely disrupted economic activities. Second, the dissolution of the former Yugoslav Republic and the associated hostilities have severely disrupted economic activity and engendered a high level of uncertainty in all the successor states. As the economic system in the former Yugoslavia was designed in part to foster close ties among the republics, its dissolution magnified the downward spiral of economic activity. In turn, the hostilities among the countries of the region set back economic development even further. These hostilities also affected the economic development of countries not directly involved. The economies of Albania, Romania, Bulgaria and FYR Macedonia were affected greatly by the break-up of neighboring economies, by the sanctions imposed on FRY, which cut off important markets and transit routes for almost all of the countries of the region, and by the destruction of regional infrastructure, most notably in the recent Kosovo crisis.

2.24   Finally, the poor economic performance also reflects inadequate progress on structural reforms (see Table 2.6). These economies have not taken the complete step towards free market economies. Commitment to reform in South Eastern Europe has been "stop and go". Across-the-board, structural reforms have lagged behind those of the CEE economies, although progress has been greater than in the Commonwealth of Independent States (CIS). The average EBRD transition indicator for SEE countries was 2.19 in 1999, compared to 3.16 for the CEE economies and 1.76 for the CIS.¹⁷ Overall, Croatia appears to have been the most successful in the area of economic reform, often close to the performance in CEE countries (see Chart 2.5).

2.25   Measurable progress has been made in the development of the private sector in virtually all countries in the region. In 1989, only 12 percent of the GDP of the SEE region were produced by private sector entities. Over the first five years of transition, this share rose to 39 percent. Today, the private sector currently generates the majority of GDP (almost 60 percent) in all countries in the region (see Table 2.6). Nevertheless, this share still remains low in comparison to the progress achieved in the Central European economies. Moreover, progress in Bosnia and Herzegovina and probably FRY, have lagged far behind progress in the other SEE countries. In Bosnia and Herzegovina, the private sector still accounts for only 35 percent of GDP.¹⁸ While reliable data do not exist in FRY, it is estimated that some 86 percent of all employment is still in state-or socially- owned sectors, indicating that the public sector still accounts for a large share of overall economic activity.

2.26   Alongside the progress in establishing private sector activity in the SEE economies, considerable progress also has been made in liberalizing markets and trade and foreign exchange systems. Trade and foreign exchange regimes in the region have been relaxed and many quantitative and administrative import and export restrictions have been lifted. Nevertheless, a further lowering of trade protection, through the elimination of non-tariff barriers, more uniform and lower tariff structures, and fewer tariff bands is still warranted, especially in light of the need to integrate more closely with Western Europe. Price liberalization has also seen substantial progress and state procurement at non-market prices has been largely phased out. Competition policy and legislation have been set up in some countries of South Eastern Europe, yet enforcement actions to reduce abuse of market power have been limited.

2.27   Privatization has made considerable headway in South Eastern Europe. Significant proportions of large-scale enterprises have been privatized in all countries—although the methods of privatization of medium-sized and large enterprises have been quite different. In most countries in the region, privatization has significantly benefited insiders, either through voucher privatization with significant concessions to insiders or through MEBOs. Bulgaria is the only country in the SEE region where the primary privatization method has been in the form of direct sales. In contrast to the difficulties in privatizing medium-sized and large enterprises, privatization of small firms has been much easier. In the countries of the former Yugoslavia, small-scale privatization was initiated before the start of the transition. In Albania, Croatia and FYR Macedonia, the privatization of small-scale industries has been completed. In Bosnia and Herzegovina, a large part even of small enterprises is still held by the state. This largely reflects attempts to maintain control over assets according to political and ethnic criteria. In summary, privatization progress, as measured by the EBRD averages 3.1 for the countries of the SEE region. Their performance in small-scale privatization has been especially good. Nevertheless, progress still lags that of the five economies of Central Europe.

2.28   The progress on privatization has made improving the environment for private sector development especially important. Poor corporate governance remains a key obstacle to enterprise restructuring and sustainable growth. The index of enterprise reform averages only 2.2 in the EBRD rankings—again significantly lower than in the five CEE, although progress in these economies has also been limited (only 2.9). Privatization through vouchers and MEBOs has produced insider-dominated governance structures in most countries of the region. Corporate control is often exercised by management without effective checks by dispersed outside shareholders or by the state. The mix of insider control, dispersed outside shareholders and residual state ownership has inhibited restructuring, and especially reductions in the work force. Yet there is little evidence that majority ownership by domestic outsiders has resulted in faster restructuring. There is evidence, however, that the profitability of new enterprises and enterprises with a majority foreign owner exceeds that of domestically privatized companies.

2.29   Only very limited progress in improving competition and governance structures has been achieved across the region. While most states have taken some steps to tighten credit and subsidy policies, considerable soft budget constraints still exist throughout the SEE region. There are a variety of ways in which the budget constraints of enterprises are eased in transition economies. Perhaps the most direct way that governments support enterprises is through budgetary subsidies to producers and through soft government loans. While these production subsidies have been substantially reduced, they still amount to 0.3-2.6 percent of GDP across the SEE region. A further, and probably more significant, means of support for enterprises is the tolerance of tax arrears and the non-payment of utility bills. Survey evidence shows that on average almost one-third of firms in Bulgaria, Croatia and Romania failed to pay all of their taxes—with the share being highest in Croatia, followed by Romania and Bulgaria.¹⁹

2.30   Banking systems in the SEE region are plagued by a lack of competition and State interference. With the exception of FYR Macedonia, all SEE countries banking systems include a large proportion of assets controlled by state-owned banks which are generally under ongoing restructuring and privatization programs (see Table 2.7). Banking sector liberalization in all the SEE countries (with the exception of the FRY) has led to a rapid proliferation of small, undercapitalized and poorly supervised private banks, whose failure could pose systemic risks. Loan portfolios contain a large share of non-performing loans, ranging from between 11 percent and 91 percent of total loans, which requires large provisions that impact negatively on bank’s profitability. Banking skills and institutional weaknesses are severe, particularly in the area of banking supervision. The prudential and regulatory frameworks of SEE countries have been brought to acceptable standards (except in the FRY), though the main challenge remains at the implementation and enforcement level, especially in monitoring and verifying loan classifications. Accounting frameworks are close to nominal compliance with IAS and international standards, except in the FRY and Bosnia and Herzegovina where a major effort is still needed to bring bank accounts and prudential regulations up to international standards. Enforcement of prudential regulations (loss-provisioning in particular) remains weak across the region.

2.31   Across the region considerable progress has been made in designing a legal framework. Nevertheless, the effectiveness of the legal framework and the environment for private sector development, especially for small and medium-sized enterprises, remains problematic, depressing private economic activity and investment. In the case of commercial law, an extensive legal framework is in place in most countries in the region—with the exception of Albania and Bosnia and Herzegovina. However, the legal framework is largely ineffective in resolving commercial disputes and it may need to be updated for the requirements of an increasingly globalized world. Court proceedings often remain time-consuming and inefficient. Regulations often failed to use their enforcement powers against liquidators, directors, banks, and other financial intermediaries. Failure to take prompt corrective action, coupled with time-consuming court proceedings, means that creditors, investors and minority shareholders are often left with no real or effective legal recourse in certain jurisdictions. Enforcement of bankruptcy law is a major area of concern across the region. There are real problems with the efficiency and effectiveness of liquidation proceedings.

2.32   New enterprises and the private sector in general face considerable obstacles in doing business. Access to finance, complex tax systems and administrative burdens are the principal hurdles, especially for SMEs. The institutional infrastructure that supports SME information, legal and training needs in most western market economies tends to be weak. These obstacles emerge in an EBRD commissioned comparative study of constraints faced by SMEs in 1998, covering Poland, Slovak Republic, Romania, Ukraine and Russia. In many respects, Romania matched performance in the two central European countries and performed far better than the two CIS economies—e.g., in the growth of SMEs and the diversity of their customer base. But on other dimensions, there were severe shortcomings as compared to Poland, which offered the most favorable business environment among the five countries (see Table 2.8).

2.33   The ineffectiveness of the legal framework and the difficult climate for private sector development all hamper the investment climate in the SEE region. Business people interviewed in Albania, Bulgaria, Croatia and Romania view macroeconomic and policy instability as the major impediment to investment (see Box 2.2). This is in contrast to most other central and east European countries, where the top obstacle is taxation and regulation. Changes in regulation, taxation and other controls, often at short notice, hamper business planning. Corruption and law and order are also particularly problematic in South Eastern Europe relative to central Europe.

2.34   The past decade of transition and conflict has left in the region with a legacy of mediocre growth and declining living standards. The region has recovered only 75 percent of its pre-transition GNP. Living standards, as evidenced by higher poverty, unemployment and inequality, have also deteriorated. The underlying reason is that, while considerable progress has been made with liberalization, and in some countries with privatization, progress in structural reforms has been slow in South Eastern Europe. This includes the privatization of large key industries, as well as the imposition of financial discipline on enterprises and banks. Most importantly, the region has made little progress in establishing the legal and social institutions that underpin effective markets and provide the predictability, fairness and transparency required for private investment. As a consequence, the vicious circle of economic uncertainty—engendered by the decade of conflict in the region and the region’s unclear prospects for integration into Western European structures—and an inhospitable climate for private sector development—stemming from an inadequate pace and depth of structural reforms—have combined to yield a disappointing economic performance during the past decade.

Annex 2.1 - 2.8: Tables with selected indicators for countries and the region (pdf, 41 KB)