This Report outlines a comprehensive approach to regional development and integration in South Eastern Europe. To this end, it develops a comprehensive strategic framework for development activities in the region; it does not contain a specific agenda for regional projects, programs or financing requirements. This strategic framework responds to the Stability Pact mandate (Article 41) for the European Commission and the World Bank to coordinate a regional approach. This Report has been prepared by the World Bank, in close collaboration with our main development partners in the region.

The fundamental objectives of the strategy are increased prosperity and a reduction in poverty for all people living in South Eastern Europe. The Report’s main premise is that establishing peace, stability and sustainable growth throughout the region is essential to achieving these objectives. A deeper and more consistent implementation of domestic reform programs, stronger governance and institutions, sound environmental management, and better developed and integrated infrastructure are all needed to provide a solid foundation for sustainable growth and poverty reduction. Policies to foster social inclusion and cohesion within the increasingly fragmented region are also key, as they are the only road to establishing peace and stability.

The South East European region, as used in the Report, refers to Albania, Bosnia and Herzegovina, Bulgaria, Croatia, the Federal Republic of Yugoslavia, the former Yugoslav Republic of Macedonia and Romania. It is a diverse region of 56 million people, living at about US$2,200 per capita, roughly half the income level of the five Central European countries. The past decade of transition and conflict has left the region with a legacy of inadequate growth and declining living standards. As a region, these economies have recovered only 75 percent of their pre-transition income levels. In the past several years, growth has declined in aggregate, increasing the gap between these economies and the rest of Europe. More alarming is that there has been a deterioration in living standards, as evidenced by higher poverty, inequality and unemployment.

This poor economic performance can be attributed to four factors. First, initial conditions in the region at the onset of the transition were adverse: the economies had unbalanced industrial structures, weak institutions, and fragmented civil societies. Second, war, civil strife and ethnic conflict have had a devastating effect on the region. In those countries directly affected, conflict has fragmented societies, and destroyed institutions and infrastructure. In all countries, regional conflicts have disrupted normal economic activities, made for an uncertain business climate and put strains on nascent political systems. Third, macroeconomic stabilization policies have been inconsistent and this has furthered exacerbated the uncertain business climate. Finally, structural reform policies have been weak; progress in trade liberalization, privatization, enterprise reform, competition policies and financial sector development have all lagged the efforts in Central Europe. Similarly, disappointing progress has also been made in institutional, social and environmental policies.

Overcoming the legacy of conflict and a poor economic performance, and achieving success in the fundamental objectives of the Stability Pact requires a ‘joint commitment’ by all partners. First and foremost, the countries of the region must make a deeper and longer-lasting commitment to reform and intra-regional cooperation than has characterized the past decade. Without such a commitment, no regional strategy can be effective. Yet, as argued in the Report, an approach focussed solely on country-by-country reform and intra-regional integration is necessary, but not sufficient, to achieve our joint goals of prosperity and a lasting reduction in poverty for all people of the region. Success will, also, hinge critically on establishing a credible and predictable path for all countries in the region to integrate with European and global structures, particularly the European Union. Such a path would anchor expectations and provide a strong incentive for today’s political leaders to reform and cooperate. The international community must also support the implementation of this strategy, by providing financial, technical and political support to the countries to help them advance on the path of reform and integration with the world economy.

The Report outlines four broad thrusts for action that are designed to support the achievement of the goals of peace, stability and prosperity. These are:

• moving rapidly towards trade integration with the EU and within the South East European region itself, and creating a stable, transparent and non-discriminatory environment for private sector development;
• fostering social inclusion and social change within the region to reduce tensions and create the conditions for peace and stability;
• improving institutional capacity and governance structures, and strengthening anti-corruption efforts in the region; and,
• investing in regional infrastructure to integrate the region physically with the rest of Europe and within itself, which must include initiatives that safeguard the environment.

Improving the climate for trade and private sector development will magnify and accelerate the impact of more determined implementation of domestic reform programs. The first concrete step in eventual integration with European and global structures is trade integration. Trade integration, based on past experience in Europe and elsewhere, is usually a leading component of broader, longer term integration. The countries of South Eastern Europe are small, and thus their development depends critically on international trade and access to European markets. Trade integration is also essential to reduce the dependence of these countries on aid from the international community. Trade integration must also be accompanied by the creation of vibrant private sectors. Without an improvement in the climate for investment and private activity in general, the countries of the region will be unable to realize the benefits of trade integration and will not be able to generate the new employment opportunities necessary to raise living standards.

Given existing ethnic tensions in the region, special efforts are required to include more fully and effectively all population groups in the economic development of the region, especially minority groups. Currently, the region has about 1.7 million refugees or internally displaced people. These people are separated from their ancestral homes and their physical and economic assets. They create a cauldron of instability in the region. Furthermore, continued increases and persistence of poverty among these people and other minority groups will exacerbate tensions and could lead to a further fragmentation of the region. Ensuring equal access to public services and employment is critical. Efforts also need to be made to reach out to the Roma community, which lives in poverty in many countries of 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 for regional cooperation. The ultimate goal must be the formation of open, tolerant and cohesive societies that provide the foundations for a stable and prosperous region.

Much of economic development, social inclusion and regional stability in South Eastern Europe will depend on strengthening of institutions, governance and a lowering of the level of corruption. Gradual integration with European and global structures will also require significantly more mature institutional structures. Institutions also play an essential role in poverty reduction, by assuring that public services are delivered to all members of society, including the poor. Cross-country evidence shows that South Eastern Europe has very weak institutions and governance, which constrain economic development and adversely affect investors’ perception of the region. Special attention will need to be given to combating corruption. The agenda for action in these areas is large and includes: greater transparency and accountability in the functioning of state institutions, better internal controls, including auditing and financial management, a reduction in administrative discretion and greater participation and oversight from civil society.

Finally, economic growth and regional integration will depend on a better and more efficient infrastructure base and reversing decades of environmental degradation. Wars and civil conflict have resulted in considerable damage to infrastructure. Fiscal pressures during the 1990s have contributed to the deterioration of infrastructure, through limiting maintenance expenditures and the resources available for critical infrastructure investments. An improved infrastructure base, integrating the countries of South Eastern Europe with the rest of Europe is, therefore, essential to achieving prosperity. War-related damage and years of environmentally unsound development have conspired to threaten the long-term sustainability of economic growth. Environmental degradation has also impacted the poor disproportionately, as the poor tend to rely more on natural resources for their livelihood. Many environmental issues are regional in nature, as the countries of the region share many natural resources and major waterways. Working together to reverse environmental degradation and to strengthen environmental policies and institutions is necessary to underpin long-term sustainable economic development and achieve long-lasting prosperity throughout the region.

A concerted effort of the countries of the region to implement deeper and more consistent reform programs, alongside the efforts of the international community to integrate these countries into European and global structures and to provide assistance in key areas, offers the best hope for achieving peace, stability and prosperity throughout South East Europe.