Regional Economic Development in the Balkan Region [1 ed.] 9781443887618, 9781443885270

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Regional Economic Development in the Balkan Region

Regional Economic Development in the Balkan Region Edited by

Teoman Duman, Merdžana Obralić, Erkan Ilgün and Uğur Ergun

Regional Economic Development in the Balkan Region Edited by Teoman Duman, Merdžana Obralić, Erkan Ilgün and Uğur Ergun This book first published 2016 Cambridge Scholars Publishing Lady Stephenson Library, Newcastle upon Tyne, NE6 2PA, UK British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Copyright © 2016 by Teoman Duman, Merdžana Obralić, Erkan Ilgün, Uğur Ergun and contributors All rights for this book reserved. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner. ISBN (10): 1-4438-8527-4 ISBN (13): 978-1-4438-8527-0

TABLE OF CONTENTS

Acknowledgements .................................................................................. viii List of Abbreviations .................................................................................. ix Chapter One ................................................................................................. 1 Introduction Teoman Duman Chapter Two .............................................................................................. 10 Bosnia and Herzegovina, from the Self-Sustainable Economy to Unfinished Transition: What's Next? Sead Kreso, University of Sarajevo, Bosnia and Herzegovina Chapter Three ............................................................................................ 40 Progress of the Transition in the Southeast European Countries Wioletta Nowak, University of Wroclaw, Poland Chapter Four .............................................................................................. 54 Trade as a Factor of Economic Development in the Western Balkans Predrag Bjeliü, University of Belgrade, Serbia Chapter Five .............................................................................................. 66 Foreign Direct Investment in the Western Balkan Transition Economies: Future Perspectives Eldin Dobardžiü, Sarajevo School of Science and Technology, Bosnia and Herzegovina Chapter Six ................................................................................................ 87 The Effects of Tax Incentives on Regional Economic Development Mine Biniú, Balkesir University, Turkey Elif Ayúe ùahin øpek, øzmir Katip Çelebi University, Turkey Chapter Seven.......................................................................................... 132 Causal Relationship between Trading Volume and Security Returns: A Case Study of the South Eastern European Region Jasmina Okiþiü, University of Tuzla, Bosnia and Herzegovina

vi

Table of Contents

Chapter Eight ........................................................................................... 150 Two Transitions in Croatia Ivan Lovrinoviü, University of Zagreb, Croatia Marko Primorac, University of Zagreb, Croatia Tea Lovrinoviü, Johannes Gutenberg Universität, Germany Chapter Nine............................................................................................ 180 The Role of Regional Development Agencies in Reducing Regional Development Disparities: The Case of Izmir Development Agency Ergüder Can, The Ministry of Interior, Turkey Chapter Ten ............................................................................................. 196 The Role of Behavioral Economics in Bosnia and Herzegovina: Does Remittances and Foreign Aid have an Adverse Effect on Economic Development? Aida Soko, Deloitte Overseas, Bosnia and Herzegovina Chapter Eleven ........................................................................................ 210 The Exchange Rate and its Connection with Import-Export Alba Cani, Epoka University, Albania Chapter Twelve ....................................................................................... 231 What are the Measures for the Best Fiscal Policy in Albania? Besjana Laçi, Epoka University, Albania Eglantina Hysa, Epoka University, Albania Chapter Thirteen ...................................................................................... 246 People’s Motives in Utilizing the Freedom of Movement within the EU as a Result of Visa Liberalization Policies: Case Study of Kosovo Alban Asllani, AAB College, Kosovo Shkumbin Misini, Public University Kadri Zeka Kosovo Kujtim Bytyqi, Kosovo Security Council Secretariat, Kosovo Chapter Fourteen ..................................................................................... 274 The Impact of Public and Private Tourism Investments on Tourism Performance and GDP: Case Study of Balkan Countries Kemal Kantarc, Akdeniz University, Turkey Mustafa Ünver, Gumushane University, Turkey Kazim Develio÷lu, Akdeniz University, Turkey

Regional Economic Development in the Balkan Region

vii

Chapter Fifteen ........................................................................................ 285 Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina Teoman Duman, International Burch University, Bosnia and Herzegovina Chapter Sixteen ....................................................................................... 310 The Abandonment of the Poverty-Debt Cycle by Dint of Fiscal Policy: The Modest Bosnia and Herzegovina Experience Zehra Mahmutoviü, International Burch University, Bosnia and Herzegovina U÷ur Ergün, International Burch University, Bosnia and Herzegovina Chapter Seventeen ................................................................................... 322 The Microfinance Tale: Bright and Dark Side of the Narrative Zehra Mahmutoviü, International Burch University, Bosnia and Herzegovina Ali Coúkun, Fatih University, Turkey

List of Contributors ................................................................................. 341

ACKNOWLEDGEMENTS

As the editors of this current volume, we are grateful for the efforts of a number of contributors to this joint work. The book comes after hard and patient work, and makes a significant contribution to the academic community who are interested in the topics offered in it. The collection reflects not only the academic publications of its authors, but also conveys first-hand experience of authors who have lived in the region for many years, which makes the book special among its counterparts. Taking this opportunity, first, we would like to thank to all authors in the book for their great contributions. Also, we would like to thank International Burch University and its Faculty of Economics and Social Sciences staff members for their support to this collection. Among, them, Mrs. Emina Mekic deserves special thanks for her assistance during the preparation stage of the book. Overall, the book is a product of a fruitful cooperation among academics coming from different parts of the Balkans. We are all happy to make such a contribution to our region.

LIST OF ABBREVIATIONS

BH CBA CBBH CEEC CEFTA CNB CSE DA DAKAP DAP DOKAP EBRD EU FDSS FDI FTA FYROM GDP GFC GLPS GMP IIC IMF INSTAT IZKA MCOs MFIs NUTS OECD OIZs OLS PRP RDA R&D

Bosnia and Herzegovina Currency Board Arrangement Central Bank of Bosnia and Herzegovina Central and East European Countries Central European Free Trade Agreement Croatian National Bank Colombo Stock Exchange Development Agency South-eastern Anatolia Regional Development Project Eastern Anatolia Project Master Plan Eastern Black Sea Regional Development Plan European Bank for Reconstruction and Development European Union Fiscal Discipline and Sustainability Strategy Foreign Direct Investment Free Trade Agreement Former Yugoslav Republic of Macedonia Gross Domestic Product Global Financial Crisis Group for Legal and Political Studies Gross Material Product Investment Incentive Certificate International Monetary Fund Albanian Institute of Statistics Izmir Development Agency Microcredit Organisations Microfinance Institutions Nomenclature of Units for Territorial Statistics Organization for Economic Co-operation and Development Organized Industrial Zones Ordinary Least Squares Method Priority Reconstruction Program Regional Development Agency Research and Development

x

SEE SETX SME SPO SSK TL T&T TURBAN TURSAB UNWTO U.S. VAT VAR WWII WTTC YHGP ZBK

List of Abbreviations

South East Europe South-Eastern Europe Trade Index Small and Medium Enterprises State Planning Organisation Social Insurance Institution Turkish Lira Travel and Tourism Turkish Tourism Bank Association of Travel Agencies United Nations World Tourism Organisation The United States of America Value Added Tax Vector Autoregressive Model World War II The World Travel & Tourism Council Yeúilrmak Basin Development Project Zonguldak-Bartn-Karabük Regional Development Project

CHAPTER ONE INTRODUCTION TEOMAN DUMAN

Technological progress in manufacturing, transportation and communications has been continuing at a dizzying speed in recent history. The invention and development of new technologies, such as the semiconductor silicon chip and satellite technology have reshaped the economic structure of many regions and nation states. Stimson, Stough and Roberts (2006) attribute such changes to globalisation and structural adjustment, which were triggered by the development of new technologies starting in the 1970s. The effects of these technologies on economic structures were mainly due to “highly skilled and flexible labour, management and strategic alliances that are all highly mobile” (Stimson, et al., 2006). The use of such new technologies called for a big shift from manufacturing-oriented and energy-dependent economic environments to environments where labour, goods and services moved much more freely, both inter-regionally and internationally. Coupled with rising energy (oil) costs, financial deregulation and globalisation of financial markets in the 1970s, the development of these new technologies forced many nations to eliminate trade barriers and enter into the new era of globalisation. Changes in global economic environments also brought about changes in regional economic structures. Previous energy-dependent mass production centers were dominated economically by modern high technology regions, such as Silicon Valley. Such changes in regional economies have occurred not only in manufacturing and technology production centers, but also in agricultural and trade centers. Currently in the world, there are “new geographic clusters of industries” and “mega metro regions that serve both national and international markets” (Stimson, et al., 2006, p. 2; Amin and Goddard, 1986; Erneste and Meier, 1992). Castells and Hall (1994) rightly point out the fact that mega metro regions are seen as the main drivers of economic development beyond the effect of nation states (Stimson, et al., 2006, p. 2). Many examples of

2

Chapter One

regional economies (not as nation states) worldwide can be assessed by their economic centers in terms of manufacturing, trade and technology development. Despite political restrictions, changes in economic environments force nations to eliminate borders to achieve easier movement of information and financial assets, and to promote travel. Economic difficulties that are experienced even in developed nations (i.e., economic crises of 2008) motivate businesses to cooperate more with others to benefit from their strengths. The appearance of recently developed, highly specialized economic regions is also changing the international trade paradigm. Just as nations have looked for comparative advantage in the past, these economic power centers are now looking for competitive and collaborative advantage (Porter, 1990; Huxham, 1996). A planned approach to economic policy change that will bring competitive and collaborative advantage to regions and national economies necessitates a strategy. Planning and policy development are needed at both the macro and micro levels. The efforts toward establishing economic unions and political alliances at the national level are examples of macro policies, whereas, establishing technology, science and innovation parks are examples of micro-level policies to reach regional economic development. This book aims to discuss different aspects of regional economic development of the Balkan region. As mentioned briefly, there are many reasons why economic development is not only a national matter but also a concern at the regional level for many economies. Most national leaders would agree with the idea that competing at the regional level is more practical than competing at the national level for protection of national interests. By definition, “regional economic development is the application of economic processes and resources available to a region that results in the sustainable development of, and desired economic outcomes for a region, and that meet the values and expectations of business, residents and visitors” (Stimson, et al., 2006). The ultimate goal of regional economic development is to stimulate business activity and employment in a sustainable manner (Blakely, 1994). More specifically, the products of healthy regional economic development are employment, wealth, investment, infrastructure, and quality of life overall (Stimson, et al., 2006). The process and the products of regional economic development are given in Table 1-1.

Introduction

3

Table 1-1: Regional economic development as a matrix of qualitative, quantitative, process and product outcomes Regional economic development matrix

Qualitative

Quantitative

Inputs and outputs

Inputs and outputs

Inputs and outputs

Inputs and outputs

Regional economic process Policy Planning Analysis Strategy Resource Application, etc. Regional economic product Employment Wealth Investment Infrastructure Quality of life, etc. Source: Adapted from Stimson, R. J., Stough, R. R. and Roberts B. H. (2006)

To reach the desired outcomes, a well-planned economic development process is necessary. As a first condition of this process, policy development at the national or regional level has to be achieved to set the groundwork for future planning. Well-worked, agreeable and sustainable policy development will open up all channels for workable development plans. Short-term and long-term plans are needed to guide all related parties to a common goal. Plans should reflect strong and weak sides of regional resources and parties should benefit from all opportunities for the region as a whole. All inputs and outputs of regional economic development should be defined qualitatively and quantitatively. Quantitative inputs and outputs include tangible aspects of regional resources and outputs, such as goods, services, raw materials, expertise and financial outcomes. Qualitative inputs and outputs, on the other hand, include intangible aspects, such as social and intellectual capital, values, culture and the resulting effects on the quality of life.

4

Chapter One

Stimson, et al., (2006) propose that in a process model, drivers of regional economic development are factors of investments at the level of consumption and effective governance, and they are created through external and internal sources of wealth (p. 8). External sources of wealth can be created through income from external investments, grants and private capital, while internal sources of wealth are created out of inputs from profits, dividends, savings assets and social capital. To achieve desired outputs, such as increasing levels of exports and wealth creation, mediators such as a competent workforce, effective institutions, welldeveloped infrastructure (at the regional level), and innovation and commercialization of new products and services (at the firm level) are needed. Regional policymakers should make use of external income (i.e., exports) and internal sources of wealth (i.e., profits) in such a productive way so that drivers of the strategy (i.e., investments, consumption) produce the desired outcomes in a sustainable way. Here, sustainability refers to reducing the leakage of capital from activities to support development at the regional level. Stimson and his colleagues further argue that the strategy of regional economic development described above is a representation of the model successfully applied by some regional economies in different parts of the world. The success of regions like the Third Italy, West Jutland in Denmark, Bangalore in India, and Silicon Valley and Route 123 in the United States (U.S.) in innovation of new technology and entrepreneurial activity can be explained in part by the application of regional economic development policies. Other examples abound in different sectors, such as tourism, agriculture, mining and manufacturing. Just as there are successful examples of regional economic development, there are many others that have potential but limited application of such progress. For this book, the Balkans is a case in point. The purpose of the collection of academic papers presented in this book is to draw attention to the fact that the Balkans as a region should and can be a good prospect for developing regional economic development policies for the future. As a geographic region, the total area of the Balkans is 666,700 square km with a population of 59,297,000 (Danfort, 2015). The following twelve countries are fully or partially located in the Balkan Peninsula.

Introduction

5

Table 1-2: The Balkan countries Balkan countries

Area

Location in the Balkan peninsula as a country

1

Albania

28,748 km2

Fully located

2

Bosnia and Herzegovina

51,197 km2

Fully located

3

Bulgaria

110,993 km2

Fully located

4

Croatia

56,594 km2

Partially located 2

5

Greece

131,990 km

Fully located

6

Kosovo

10,887 km2

Fully located

2

Fully located

7

Macedonia

25,713 km

8

Montenegro

13,812 km2

Fully located 2

9

Romania

238,391 km

Partially located

10

Slovenia

20,273 km2

Partially located

2

11

Serbia

88,361 km

Partially located

12

Turkey

23,764 km2

Partially located

Source: Bideleux and Richard (1996)

There are many reasons why the Balkans area should be analysed for regional economic development. One main reason is its location. Throughout history, the Balkans has always been the corridor of European nations to open up trade between Eastern and Mediterranean nations. Geographically, this region is a part of Europe, and there are strong economic and social ties among the Balkan and other European nations. For a long period in history, the Balkans was part of the Ottoman Empire, but this governance helped eastern and western nations to get closer to each other through the connection that the Balkan nations provided. This connection brings out the fact that economic and social policies for this region will benefit not only its own nations, but other nations in Europe and in the East. Another reason for economic development is related to the Balkan social structure. This region houses such diverse population structures that it presents the perfect human potential for sociological dynamism. The regions’ populations know each other’s cultures very well and are ready to cooperate on issues that will bring about the common

6

Chapter One

good for everyone in the region. In addition to geographical and sociological reasons, there are many other economic reasons why this region is a good prospect for regional development policies. Some sectors, such as tourism, energy, mining and agriculture, are especially strong in the area. Attempts to energise the economy in the region have been continuing for some years, especially with the policies to integrate the Balkan countries into the European Union (EU). Romania, Bulgaria, Greece and recently Croatia have joined the EU, and the efforts of other countries in the region are continuing. Although the region has many opportunities for national economies and their outer-regional integration, recent war and the political conflicts following the breakup of Yugoslavia in 1992 have prolonged the process of integration. Glogorow, Kaldor and Tsokualis (1999) pointed out that for the EU as a big power in the region to be effective in helping the Balkan countries to complete their transition processes, political will, financial resources and innovative ideas are needed. Political will is necessary for policy development and planning, whereas financial resources and innovative ideas are needed to achieve regional economic development. According to Glogorow et al. (1999), an important part of efforts to establish policies for regional development should be focused on safety and security in the region. Also, the development of intraregional policies (i.e., trade) should be prioritised as compared to outer-regional ones, especially in the short term. Cooperation on regional development policies by the Balkan countries is also needed due to the fact that many economies in the region are small in size (Causevic, 2012). Development of strong financial systems (through cooperation) in the region is one of the steps that can be taken towards regional economic development policies. Currently, most countries in the region are considered to be transition economies, and they are in need of joint efforts to benefit from each other’s strengths. This book points out the need for regional economic development policies for the Balkan region and brings together insights from academics on various economic and social aspects of regional development. An original collection of ideas from a number of academics from different countries in the Balkan region, the book starts with a critical investigation of the transition that Bosnia and Herzegovina has been going through following the separation of countries from Yugoslavia during the 1990s. In the next chapter, Nowak investigates the progress of transition in some Balkan countries in transitioning to an open, market-oriented

Introduction

7

economy. Nowak compares nine Balkan countries to identify the ones that have gotten closest to open market economic conditions. The next chapter in the book concerns with the foreign trade positions of Balkan countries. In this chapter, Bjelic considers foreign trade as a factor of economic development in the region. The chapter analyses the trade performance of some Balkan economies and the impact of regional trade integration on their development. In the following chapter, Dobardzic investigates foreign direct investment positions of selected Balkan countries and analyses the role of political instability on foreign direct investment positions of these countries. He also points out the temporal effects of privatisation policies on foreign direct investment positions in these countries. Subsequently, Binis and øpek attempt to identify the role of tax incentives on regional economic development through an analysis of Turkey’s experience on the issue, in which they try to identify how tax incentives and new investment developments are related to each other. The other chapters in the book present more specific aspects related to regional economic development in the Balkan region. The chapter by Okicic talks about trading volume and security returns in Balkan stock markets. Lovrinovic and his colleagues present an up-to-date discussion on the two transitions Croatia has been going through after gaining EU membership. In this chapter, the authors discuss the effects of EU membership on the Croatian economy using specific examples. In the following chapter, Can presents a discussion on the role of regional economic development agencies on regional economic development with reference to the experience of one development agency in Turkey. He discusses the structure and operation of the Izmir Development Agency as a model institution for regional economic development planning in the eastern part of Turkey. In her paper, Soko analyses the roles of foreign aid and remittances in Bosnia and Herzegovina’s economic development and compares this effect with other Balkan countries. Additionally, Soko tries to identify whether foreign aid and remittances have any effect on the country’s overall development. The following two chapters are about Albanian economic policies. In the first one, Cani analyses exchange rates in Albania and tries to answer whether exchange rate volatility has any effect on export-import levels of the country. She argues that for the period she analysed, exchange rates had no effect on import levels; however, these rates had significant effects on export levels in the country. Laci and Hysa provide a detailed analysis on Albanian fiscal policies and try to determine the roles of different fiscal

8

Chapter One

policies on the economic growth in the country. They argue that VAT policies are effective in regards to the economic growth in Albania. Asllani and his colleagues analyse Kosovo residents’ motives in their travel activities to the EU countries and provide a policy perspective on the economic development in their country. They try to understand the effects of visa liberalization policies of EU on countries like Kosovo, with their findings showing that after visa liberalisation policies, participating tourism and research activities are the two main reasons for visits to EU countries. The following two chapters analyse the role of the tourism industry in the region’s economic development. In their chapter, Kantarci and his colleagues attempt to correlate the effects of both public and private investments in the tourism industry in regards to tourism performance and gross domestic product (GDP) levels in selected Balkan countries. Based on their findings, they point out certain priority sectors for tourism development and GDP growth. In the next chapter, Duman provides a policy perspective and compares Bosnia and Herzegovina with Turkey in their tourism development policies. In both papers, authors emphasise the role of the tourism industry in economic development of the region. The final two chapters in the book are related to Bosnia and Herzegovina; the first chapter evaluates the effects of the recent economic crises in Europe on the country’s economy while the second critically analyses the implementation of a microcredit system in the country to start discussion about future policies in this area. As mentioned before, the development of new technologies and the elimination of trade barriers have reshaped the economic structure of many regions and nation states in different parts of the world. The future calls for similar developments for the Balkan region in that many smaller economies in the region will have to cooperate more closely to reach mutual economic gains. We believe that the current volume closes a significant gap in providing the information needed to evaluate regional economic policies in the Balkans. The data and arguments provided in the book are expected to break new grounds for future discussions that will support the ideal of reaching harmonised regional economic development policies in the region.

Introduction

9

References Amin, A., Goddard, J. (1986). Technological Change, Industrial Restructuring and Regional Development. London: Allen and Unwin. Bideleux, R. & Richard, T. (1996). European integration and disintegration: East and West. p. 249. Blakely, E. J. (1994). Planning Local Economic Development: Theory and Practice. 2nd ed. CA: Sage Publications, Thousand Oaks. Castellas M., & Hall, P. (1994). Technopoles of the World: The making of 21st Century Industrial Complexes. London: Routledge. ýauševiü, F. (2012). Small open economies in the Western Balkans: Controlled fiscal expansion for a new deal for the Western Balkans. St Antony’s College University of Oxford. Danforth, L. (2015, March18).The Balkans. Retrieved from

on 18.03.2015. Erneste, H., Meier., V. (eds.). (1992). Regional Development and Contemporary Industrial Response: Extending Flexible Specialization. London: Belhaven Press. Gligorov, V., Kaldor, M., &Tsoukalis, Loukas. (1999). Balkan Reconstruction and European Integration. Hellenic Observatory of the LSE, the Centre for the Study of Global Governance (LSE) and the Vienna Institute for International Economic Studies (WIIW). Huxham, C. (1996). Collabourative Advantage. London: Sage, Thousand Oaks. Porter, M. E. (1990). The Competitive Advantage of Nations. New York: MacMillan. Stimson, R. J., Stough, R. R., & Roberts, B. H. (2006). Regional Economic Development, Analysis and Planning Strategy. Heidelberg: Springer.

CHAPTER TWO BOSNIA AND HERZEGOVINA, FROM THE SELF-SUSTAINABLE ECONOMY TO UNFINISHED TRANSITION: WHAT’S NEXT? SEAD KRESO

“Study the past, if you would divine the future”. —Confucius (about 600 BCE)

Abstract: This chapter is envisaged as a broad elaboration of the basic ideas presented at the International Conference on Economic and Social Studies (24–25 April, 2014), organized by International Burch University.i Since the University is based in Sarajevo, one of the aims of the Conference was to clarify the transition process, particularly privatisation, and to explain the delay in the ongoing economic development of Bosnia and Herzegovina (BH). In the first part of the chapter, I present facts about the economy during the dissolution of Yugoslavia and the emergence of Bosnia and Herzegovina. To do this, I need to give a brief impression of the war situation in the period 1992–1995, as well as the post-war reconstruction of BH. Next, I consider the transition process in BH, exploring the role of monetary and fiscal policy as the two most powerful instruments influencing the market economy. After that, I consider the consequences of the distinct dominance of foreign banks and bank-centric financial system in BH. My conclusions at the end of the chapter offer several recommendations. Keywords: Bosnia and Herzegovina, transition process, fiscal and monetary policy.

Bosnia and Herzegovina: What’s Next?

11

Dayton: Where did Bosnia and Herzegovina come from? Dani Rodrik, in his paper “The Past, Present, and Future of Economic Growth (2013)”, showed that during the thirty-year period 1952-82, Yugoslavia’s average growth rate was 4.9% per year. Only 23 other countries matched or exceeded that 30-year record of dynamic growth since the end of the Second World War.ii Table 2-1 confirms Rodrik’s findings, showing that Yugoslavia achieved its highest development dynamics between 1973 and 1986. During this period, Yugoslavia improved its relative share of GDP in World, Europe, and Southern Europe rankings. There were two distinctive phases within the period however. Huge investments were undertaken during the 1970s, but from 1980 onwards, numerous imbalances ensued, caused by the excessive investment of the first phase. Compared to other countries, Yugoslavia showed reputable results in economic development during the entire period from 1973 to 1986, but the downward trend became apparent at the beginning of the 1980s, accelerating in the mid-1980s. The consequent disruption of economic and social development led to war and dissolution in the early 1990s.iii Bosnia and Herzegovina was one of the six republics that made up Yugoslavia, and declared its independence on 1 March, 1992. At that time the war in former Yugoslaviaiv was already raging, having started in Slovenia in 1991, and by 1995 intensified to the point of complete dissolution of Socialist Federal Republic of Yugoslavia. Basic pre-war statistics of the former Yugoslavia are presented in Table 2-2. It is well known that the territory’s area and the size of its population represent the basic resources for development. Being basic indicators, more comparisons would be needed for a more precise view, but for the purposes of this analysis, these indicators will suffice. Table 2-2 shows that Yugoslavia’s area was comparative to Romania and Italy, and its population was slightly higher than Romania and the populations of Hungary and the Czech Republic combined. The second part of the Table provides a comparison of each republic’s population with that of comparable European countries. This approach allows us to get a basic view of the size of the former Yugoslavia, as well as its former republics, now independent states, in relation to the area and population of selected European states.

0.43

1.1

7.8

1981

0.56

1.5

9.0

In the World

In Europe

In Southern Europe

Year

In the World

In Europe

In Southern Europe

8.4

1.4

0.51

1982

7.6

1.1

0.43

1971

8.8

1.5

0.51

1983

6.8

0.94

0.39

1972

9.4

1.6

0.53

1984

7.0

0.98

0.51

1973

9.5

1.7

054

1985

8.2

1.2

0.51

7.5

1.4

0.51

1986

8.0

1.2

0.51

1975

6.4

1.3

0.48

1987

8.9

1.3

0.53

1976

5.9

1.2

044

1988

9.5

1.4

0.58

1977

Source: http://kushnirs.org/macroeconomics/gdp/gdp_yugoslavia.html#main accessed on 24/12/2014

1970

Year

1974

Chapter Two

Table 2-1: GDP of Yugoslavia, 1970-1990 (share percent)

12

5.9

1.3

0.44

1989

9.3

1.4

0.58

1978

-

1.0

0.37

1990

9.2

1.5

0.63

1979

8.3

1.4

0.58

1980

Bosnia and Herzegovina: What’s Next?

13

Table 2-2: Basic statistics of Yugoslavia’s republics in comparison to some other countries Total area Population 30/06/1986

256,000 km2

Romania 237,500 km²; Italy 301,263 km² Romania 21.5M;

23.270M

Hungary 10M + Czech Republic 10.5M = 20.5M

Republics (population) Serbia

9.657M

Austria 8.3M, Hungary 10M

Croatia

4.665M

BH

4.365M

Ireland 4.5M; Lithuania 3.3M + Estonia 1.3M = 4.6M

Macedonia

2.041M

Latvia 2.3M

Slovenia

1.932M

Estonia 1.3M

Montenegro

619K

Cyprus 0.8M

Source: OECD Economic Surveys: Yugoslavia 1987/1988

At the end of World War II, Yugoslavia was a destroyed, exhausted country. The Republic of Bosnia and Herzegovina suffered greatly, having been the scene of five out of seven offensives launched by the Germans and other occupation forces in Yugoslavia. Undaunted, its people who had liberated their homeland through heavy, heroic struggle, were full of enthusiasm and ready to rebuild and develop the country, and that with their bare hands if they had to. They succeeded in every sector with the infrastructure, industry, educational, health care, and all other sectors being restored at a high speed. The Yugoslav political elite, led by Tito, forged its own, independent way in the development of the country. Receiving significant support from the West and achieving notable economic progress, Yugoslavia soon reached a middle level of development. Much was still lacking, but the success was evident. This is clearly shown in Tables 2-3 and 2-4, which present the achieved production for structure of GDP and employment in 1986. The progress in the industry sector and the lag in agriculture are both evident (Table 2-4), but a great number of redundant workers in “Active population in private agriculture” were available for employment and able to contribute to the development and growth of industry, construction and service sectors.

14

Chapter Two

Table 2-3: Yugoslavia, production – structure of GDP* in 1986 (percentage of GDP) Agriculture, forestry and fishing

13.4

Mining and manufacturing

37.6

Building

7.3

Other

41.7

1

At that time, Yugoslavia used the aggregate GMP (Gross Material Product) as a measure. It was not calculated in the same way as GDP and did not include, for example, public services. Source: OECD Economic Surveys: Yugoslavia 1987/1988

Table 2-4: Yugoslavia, Paid Employment (1986, in 1,000) Industry

2,625

Building

586

Agriculture

239 (social sector)

Active population in private agriculture

2,200

Total

6,716

Source: OECD Economic Surveys: Yugoslavia 1987/1988

Although Yugoslavia was a federation, and therefore by definition a state with a complicated structure in terms of decision making and management, it tried very hard to minimize the number of employees in public administration. Tables 2-5 and 2-5A show that BH was not as successful in this as Yugoslavia as a whole. An overly-large public administration not only gave rise to unjustified public expenditure but also had a very detrimental effect on efficiency. Table 2-5: Yugoslavia government consolidated public sector accounts (percentage of GMP*) Year

1986

1987

Revenue, including social security

32.2

-

Expenditure

34.4

33.5

*

See note below Table 2-3

Source: OECD Economic Surveys Yugoslavia 1987/1988

Bosnia and Herzegovina: What’s Next?

15

Table 2-5A: BH Government Consolidated Public Sector Accounts (percentage of GDP) Year Revenue of General Government (as a percentage of GDP) Expenditure of General Government (as a percentage of GDP)

2008

2009

2010

2011

2012

43.6

42.5

43.7

44.1

44.5

45.8

47.0

46.1

45.3

46.6

Source: CB BH, 2013; Main Economic Indicators

In 1987, international and domestic concerns emerged that Yugoslavia would not last under the burden of an external debt of 20 billion USD. At that time, Yugoslavia’s total external debt was smaller in relation to GDP than the external public debt of BH today. Accordingly, BH is performing better than other Balkan countries, although it has already exceeded the relative ratio of external public debt to GDP, as compared to Yugoslavia’s 1987 ratio for total foreign debt. Indeed, Croatia’s total foreign debt equals the country’s entire GDP. In fact, Croatian external debt alone exceeds that of former Yugoslavia’s external debt (see Tables 2-6, 2-6A and 2-6B). Table 2-6: Yugoslavia, external debt Year million USD *

GDP , %

1986

1987

19,026

20,242

24.46

24.51

*

To calculate the percentage relative to GDP, data was taken from: http://kushnirs.org/macroeconomics/gdp/gdp_yugoslavia.html#main accessed on 24/12/2014 Source: OECD Economic Surveys: Yugoslavia 1987/1988

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16

Table 2-6A: BH*external debt Year

2008

2009

2010

2011

2012

Government Sector, (million USD, end of period)

3,057

3,837

4,270

4,407

4,823

Government Sector, as a percentage of GDP

17.0

21.5

25.3

25.8

27.8

*

Please note that BH external debt only includes debt of the government sector whereas Croatian external debt is shown as the overall external debt of the country (Table 2-6B). Source: CB BH, 2013; Main Economic Indicators

Table 2-6B: Croatia, external debt Year

2008

2009

2010

2011

2012

External debt (million Euro, end of period)

40,590

45,269

46,527

45,901

44,861

External debt, as a percentage of GDP

85.4

101.1

104.7

103.8

102.6

Source: NBH, 2013; Main Economic Indicators

By analysing statistical data of the former Yugoslavia, we can see the potential of its economy, especially regarding export industries. In 1987, the export of finished manufactured products was approaching half, 47 percent, of the total export (OECD, 1987/1988). This meant that 60% of Yugoslavia’s imports consisted of raw materials and semi-finished products. The economy was certainly under the strong influence of state intervention, but even in current times of well-established neo-liberalism, every country is to some extent exposed to this influence. The economic results were very good, especially if compared with the current situation in BH. Yugoslavia maintained a trade deficit of between 1.1 and 1.5 billion USD; BH (just one republic of the former Yugoslavia) only managed to reduce the trade deficit from 8 billion USD in 2008 to 5.5 billion USD in 2012, and then only under the pressure of the Global Financial Crisis (GFC). Yugoslavia had significant economic potential in industrial production and the ability to export; now that the unified, larger country has split into six new and smaller countries, v not one of them has that potential or ability (see Tables 2-7, 2-7A, and 2-7B).

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Table 2-7: Ex-Yugoslavia, foreign trade Structure of exports in 1987 (percentage of GDP)

Structure of imports in 1987 (percentage of GDP)

Food, drinks, tobacco

8.7

5.8

Raw materials and semifinished goods

44.4

59.7

Finished manufactures

46.9

34.5

Source: OECD Economic Surveys: Yugoslavia 1987/1988

Table 2-7A: Yugoslavia, imports and exports by area (million USD) Year

1984

1985

1986

1987

OECD

5,360

5,643

5,698

7,240

EEC

3,567

3,694

3,860

5,039

Total (Imports)

11,996

12,164

11,750

12,603

OECD

3,746

3,735

3,749

5,726

EEC

2,639

2,617

2,600

3,980

Total (Exports)

10,254

10,642

10,298

11,425

Trade Balance

-1,742

-1,522

-1,452

-1,178

Source: OECD Economic Surveys Yugoslavia 1987/1988

Chapter Two

-7,958.5*

..

..

-197.6

-8,391.4*

Montenegro

Serbia

Slovenia

Total

..

..

-1,238.2

-22,736.2

-598.1

-10,003.4

-1,588.9

-1,599.8

-4,284.3

-4,661.7

2007

-30,347.1

-1,028.3

-12,785.8

-2,432.6

-257.4

-5,300.5

-6,225.9

2008

Source: The World Bank, WDI (World Development Indicators)

*Incomplete data.

83.8

-1,102.4

Macedonia

-3,179.1

-2,745.9

Croatia

-3,624.9

-4,345.5

2006

BH

2005

-15,731.1

985.9

-7,097.6

-1,277.1

-2,144.7

-2,002.6

-4,194.9

2009

Table 2-7B: Net trade in goods and services (BoP, in current million USD)

18

-12,302.7

589.3

-6,068.8

-1,076.6

-1,871.5

-176.9

-3,698.2

2010

-13,781.5

733.0

-7,152.6

-989.4

-2,148.8

224.0

-4,447.6

2011

-11,581.2

2,167.3

-6,743.4

-1,013.1

-2,205.7

362.4

-4,148.7

2012

Bosnia and Herzegovina: What’s Next?

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How did Yugoslavia manage to keep such a low level of trade deficit in the international exchange of goods and services? As we have said, there was strong state economic intervention, but there was also a prioritised strategy of investing in infrastructure: energy, industry, education and science, health-care and food production. In addition, a large portion of the production and trade within the former Yugoslavia became a basis for international trade for the new “small open economies” of the former Yugoslav republics. If we look at the trade balance of the former Yugoslav republic, and then at the “new-born” countries, we can see the effect of war and post-war transition: Devastated industry and agriculture as well as disrupted production and supply chains. Not surprisingly, the new republics have greater trade balance deficits.vi To summarize, Yugoslavia after World War II (WWII) became a specific social and economic “project” which contrasted the East and West. The foundations of its development were the dedicated work of a large number of citizens, social cohesion, and the predominant patriotism generated during wartime, anti-fascist resistance under the highly creative leader, Josip Broz-Tito. Post-WWII Yugoslavia was a specific “project” aimed at the development of market socialism. Although we cannot be proud of everything that happened in those times, the political elite headed by Tito transformed the Yugoslav economy from a primarily rural/agricultural set of provinces to a fairly industrialized, middle-income, united country by the end of the 1980s. Yugoslavia was a leader in understanding the concept, and developing the practice, of market socialism. Even by the early 1970s however, economic and social development dictated the need for deeper reforms to maintain the dynamics of the prosperity achieved. The reform urgently needed, we now realise, was the start of the process of privatisation – the promotion and policy of consistent transition to the market economy, based on private capital.viiThe leading Yugoslavian politicians of the early and mid-1970s lacked the vision to foresee its need and the capacity to implement it. In 1971, a new Constitution was adopted in an attempt to introduce deeper reforms, but the measures were insufficient. Tito, the President launch of globalisation nationalism across the eleven years later, and birth of BH.

for Life, died on 4 May 1980, before the open worldwide, and his death triggered the growth of country he had united. Yugoslavia disintegrated a terrible war began that would culminate in the

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The war from 1992 to 1995 in Bosnia and Herzegovina Bosnia and Herzegovina suffered greater material destruction and more civil victims than any other part of the former Yugoslavia. Not only was it the “breaking point” of escalation of the war,viii but also an intended territorial prize of its new neighbours as formed by the dissolution of Yugoslavia. Even before that, BH was underdeveloped in comparison to the rest of Yugoslavia, as it had not fully recovered from the human suffering and economic destruction of World War II (WWII).

Pre-war and post-war Bosnia and Herzegovina A document prepared for the 2nd Donors’ Conference in support of Bosnia and Herzegovina (World Bank, 1996) shows that the International Community and the Government of the Republic of Bosnia and Herzegovinaix differed sharply in their assessments of war damage to property and assets. In terms of physical losses, the government estimates the overall damages from the war at 50–70 billion USD. The economic replacement cost of the destroyed assets is huge; according to initial World Bank staff estimates it lies in the range of 15–20 billion USD (p. 10). Table 2-8: GDP in Bosnia and Herzegovina (million USD) Year

1990*

1991

GDP

10.633

8.670

...

1994

1995

1996

1997

1.254

1.867

2.741

3.423

Note: After the war, there was a change in the methodology from GMP to GDP calculation. *

GDP data for 1990 was taken from Bosnia and Herzegovina – From Recovery to Sustainable Growth (World Bank, 1997, p. 100). Source: Transition report, 1999, EBRD, p. 201

The GDP in 1990 was five times higher than the GDP in 1995. GDP per capita dropped from 1,980 USD to around 500 USD. As Table 2-8 shows, if we add the approximate wartime losses in GDP of estimated 35 billion USD to BH’s government estimates of war damage of property and assets, the total amount of losses would have grown to 85105 billion USD, not counting the effect of the many years in which the post-war BH failed to reach pre-war levels of GDP and the consequent huge loss of GDP due to the destruction of the economic base. It is, of

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21

course, impossible to put an economic value on the unprecedented human suffering, the huge number of people murdered in the ethnic cleansing campaigns, and killed in battle, and the children lost, unborn or never conceived. Finally, how do we calculate the losses arising from the postDayton management of the country and economy, as well as nearly twenty years of the political instability that has followed Dayton? Before the war, BH had a significant foreign trade surplus (Table 2-9). International trade was positive, almost 1 billion USD, for the period of six years before the war, from 1985 to 1990. This was the result of more and more successful and productive industries. At that time, BH had 1,054 million employed citizens.x Then the war started and in 1995, industrial production fell between 10 and 15% from its 1990 level (Table 2-8). Total external debt amounted to 3,518 million USD, of which 1,979 million USD was due to outstanding obligations during the war.xi Additionally, BH came out of the war with significant internal debt. Part of this was “old savings in foreign currency”. More internal debt was generated by government arrears to households and businesses, with this including unpaid wages, pensions, goods and services delivered, but not paid for, during the war as well as securities for privatisation (vouchers). BH’s condition after the war meant that urgent measures for recovery were essential. The International Community created a “Priority Reconstruction Program” (PRP) and planned to obtain the necessary funding through five donor conferences to ensure construction and sustainable development. This desired goal is still to be achieved. The primary after-war goal was documented in the World Bank Country Study Bosnia and Herzegovina – From Recovery to Sustainable Growth (World Bank, 1997). The PRP that the World Bank and EU created was worth 5.1 billion USD. Compare that with their own 1996 statement, quoted above, “according to initial World Bank staff estimates [the replacement cost of the destroyed assets] lies in the range of 15–20 billion USD.” Clearly, then, the PRP was financially highly undervalued from the start, and was inadequate to return the destroyed property and assets to their pre-war volume or value. The funds proposed by the PRP were at least three times smaller than the World Bank experts had considered necessary in the previous year.

-631

Balance

-142

1,617

1,475

1985

18

1,695

1,713

1986

184

1,473

1,657

1987

327

1,390

1,717

Source: Bosnia and Herzegovina,(1996)

Note: figures denote the total exports / imports of the former Yugoslavia.

1,877

Imports

*

1,246

Exports

1980

1988

Chapter Two

Table 2-9: BH, Total exports/imports (million USD)*

22

302

1,732

2,034

1989

322

2,289

2,611

1990

-1,454

1,734

287

1991

-10

350

340

1992

-54

61

7

1993

Bosnia and Herzegovina: What’s Next?

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Table 2-10: The GDP plan and achievements of the PRP Year

1996

1997

1998

1999

2000

Plan of GDP by PRP (million USD)

3,260

4,500

5,900

7,300

8,500

Realised (million USD)*

2,779

3,340

4,164

4,537

4,452

Implementation of the PRP, in %

85.25

74.22

70.58

60.19

53.41b

*

Author's calculation based on data from IMF. (2002, August) Source: Bosnia and Herzegovina, From Recovery to Sustainable Growth (World Bank Country Study, 1997)

GDP in BAM

4.125

6.116

7.559

8.603

9.611

GDP in € (1€ = BAM 1.95583

2.109

3.127

3.865

4.399

4.914

1.7614

1.8343

2.1189

Average exchange rates BAM/USD *

Note: The estimated level of GDP in 2002 relative to 1989 was 54%; Source: EBRD, Transition Report, 2003, p. 56. Source: GDP recalculated from data in the EBRD Transition Report, 2003, p. 127 Source: Exchange rate BAM/USD, CB BH Bulletin, no. 4, 2003, Table 39 According to the original plans of the implementation (the target year was 2000), the Priority Reconstruction Program aimed: 1. To bring production up to two thirds of its pre-war value, and, 2. To establish a better balance in the flow of international trade, with appropriate mobilisation of domestic resources. There were many additional elements, but these two were the most important. The PRP has stimulated BH recovery to some extent, but it has failed in many respects (see Table 2-10).xii

24

Chapter Two

Transition process in Bosnia and Herzegovina The term transition can have many meanings, even if we look only at its economic connotations. To define it properly for our purposes, we need to understand it in context –the specific processes that constitute the transition and the time and circumstances under which they occur. In the narrowest economic focus and in the context of Eastern European countries in the late 20th and early 21st centuries, transition is defined as the transformation of state and social capital and property into private capital and property, or the “initial accumulation of private capital”xiii to trigger consistent development of a market economy based on private property and capital. BH is in the process of transition. However, a completely private, market economy has significant shortcomings, and history shows that it will not work without government intervention. Institutionsxiv and compliance for the transition are therefore both essential to the adequate functioning of a modern market economy and as such are major issues for BH’s transition. The transition in BH began with the post-war Priority Reconstruction Program (PRP). The principal strategy was to develop an economy based on small and medium size enterprises, thus instantly curtailing a large part of the pre-war industrial capacity.xv The government and the directors of large companies were seeking ways to recover large enterprises, but had no opportunity to become eligible for loans. The war had not only put big companies at a disadvantage, but the disintegration of Yugoslavia also led to the disintegration of the market in which they operated, and to the interruption of the input-output flows in their manufacturing operations. Their inability to modernize during the war meant that the technological capacity of the firms was outdated. They all lost market share, both externally and internally with a market of 20 million potential customers in Yugoslavia having vanished. Unrealistic desires for the recovery of BH’s large companies, which had been so successful internally and as exporters before the war, only created false hopes and expectations of the workers employed in them. This became a space for their manipulation by politicians, and sometimes economically irrational investment of public funds to help restore production in these companies was made. The outcome of these false hopes was the recent march of about 200 workers from four, large pre-war companies. They marched 77 kilometres from Tuzla to the Croatian border seeking admission, as economic migrants or asylum seekers, to the European Union (Croatia is an EU member state).xvi Apart from the

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25

revitalisation of smaller units of the large companies, these companies were not restored. Only a few remain functioning, mainly as public companies, such as Elektroprivreda and Telecom in the Federation of BH (FBH, one of the entities of BH). Some of them, for example Željeznice FBH (FBH Railways), have huge difficulties. A few companies have received strategic investment: Zenica Steelworks became Arcelor Mittal Zenica, Mostar Aluminium also received foreign capital, and Cementara Kakanj became Heidelberg Cement. Privatisation in BH, from the standpoint of the majority of the pre-war industry, and of particularly large enterprises, was finally expressed as an accumulation of property owned by a relatively small number of individuals. Recapitalisation of the large companies never happened, and many of them were ruined.xvii Consequently, BH has a high structural unemployment rate, with little or no growth and a great deal of unused potential. On 28 February, 2014, there were 556,892 unemployed individuals in BH.xviiiThis is arguably the greatest problem facing BH today, and there are at least four separate reasons for it. Firstly, is there a lack of foreign investment? Note that transition is a difficult, highly-demanding process, and that any public asset can be privatized only once. No potential investor is going to look at the long term when the basic motivation in the process of privatisation is to snatch as much wealth as possible and in the shortest possible time. Players who are agile enough to do that cannot simultaneously work patiently on the revival of the former big companies. Their vision of wealth that can be snatched (after the international community limited loans to 300,000 BAM at the beginning of the PRP, thus breaking the production chains of the big companies and destroying both their internal and external markets) was and still is to win the biggest “bite” of property available through privatisation. Foreigners would typically only express any interest when these assets and/or resources are properly introduced in “the books” at the courts. Only when that happens can we expect a higher volume of foreign investment in the industry of Bosnia and Herzegovina. Note that the International Community has made great efforts to reorganize the payment system, and for the privatisation of the banking sector, to establish an adequate legal framework and institutional infrastructure in the entities’ Ministries of Finance, including “units” for the privatisation of the banks. Nothing similar has been done for the privatisation and restructuring of other BH industries.

26

Chapter Two

Secondly, the ethnically heterogeneous population in comparison to a country like Croatia which is much nearer to homogeneity. Even in an ethnically homogeneous country, privatisation has a strong effect because it leads to strong social stratification. The effect is intensified in BH because its multi-ethnicity makes privatisation, and hence transition, much more difficult and socially more delicate. Specifically, there is constant pressure for the use of nationalism to protect the exclusivity of privatisation by the national elites, reserving the benefits for their own specific territories within BH. Multi-ethnicity, which creates political as well as economic difficulties, has complicated the transition and slowed progress towards privatisation and the development that should accompany it. The third reason is the remarkable problem of excessive employment in administration and public companies, a phenomenon increasingly aggravated by nepotism. Anybody who can join the civil service or a public company enters a safe zone with comparative job security and a wage guaranteed by government, and it is therefore a very desirable goal for those who used to work for large (state-owned but now collapsed) industrial enterprises. The nepotism originates from politicians, once in power, who employ their own relatives, friends, and politically suitable associates. Consequently, the state administration and public companies have become so markedly inefficient that they contain supernumerary employees. Lastly, the government is utterly irresponsible in managing public money. If we correlate the increase in wages and social benefits with the increase in nominal GDP (arguably a very reasonable approach) in the six years from 2006 to 2011, on the consolidated accounts of the BH Government, the potential saving would be, on the basis of public spending on wages 1,269 million BAM, and on the basis of public spending on social benefits 3,743 million BAM –a total of 5,012 million BAM available for (public) investment. And that is taking the financial crisis effects into consideration.xix How many kilometres of highway in BH could be built with that money, and what are the investment multipliers, accelerators, and so on? Definitely, the most important change needed for Bosnia and Herzegovina is to reverse the current “spontaneous development strategy,” based on personal consumption, to create a well-designed, precisely focused development strategy based on savings and investments. Unemployed resources and unemployed people generate less income,

Bosnia and Herzegovina: What’s Next?

27

less spending, less taxes and savings, less investment and even less employment. In addition, as described above, we have an incredibly wasteful government. The result is postponed transition and development. While citizens live in poverty, politicians spend public money wastefully. Politicians use all possible means to stay in power, and that behaviour affects the confidence of investors. The risk of social explosion is growing every day. Recently we have seen the strikes of February 2013 turned into arson of the buildings of several cantonal governments and other institutions, and even of the building of the Presidency of Bosnia and Herzegovina. Desperate unemployed workers of large enterprises in Tuzla have tried group emigration to the EU because they can no longer feed their families. Urgent, forceful change is vital. If economic and (especially) political change is too slow, too small, or insufficiently energetic, we shall see more frequent and more intense social disturbances.

Monetary and fiscal policy Monetary and fiscal policies are the two most important instruments in market economy management. It would be logical to ask, therefore, “Why does BH need a Currency Board Arrangement (CBA) and a meaningful fiscal policy based on a clear and carefully focused development strategy?” It is needed because, although BH’s very “expensive” CBA structure contributes strongly to macroeconomic stability, its fiscal policy mechanism (as it stands) consumes a huge amount of public money irresponsibly and wastefully. These funds could be better used, for example, to run public investment and employment, and thus provide a better life for all citizens. However, that will not be possible without tighter rules for fiscal policy management as well as an adequately designed development strategy for the whole country. What roles do monetary and fiscal policies play in a small open economy in 2015? First, nothing can be achieved by using discretionary monetary policy measures. Monetary policy is the most important instrument for maintaining macroeconomic stability in a small open economy. In principle, it should act equally and homogeneously in the whole economy. Its first and most important task is to maintain a stable and equal value of money in all sectors of the economy.xx If it can do that, it caters for macroeconomic stability. It is predominantly “neutral,” so there should be no selective credit policy. If it is still needed, then it is better to include a fiscal policy through, for example, subsidizing interest.

28

Chapter Two

Second, the fiscal mechanism, by its nature, has a very different scope from that of the monetary policy. Fiscal policy can act selectively, and can therefore be tailored to support country-specific development objectives.xxi The two policies have to work together so that they can jointly enable the achievement of reasonable stability and development. Hence, the best solution for monetary policy in BH is the Currency Board Arrangement, which we currently have, and for fiscal policy to be prudent and thrifty. The fiscal policy should focus on achieving macroeconomic stability too. It should apply well-rounded, versatile measures designed to achieve the objectives of an appropriate development strategy that adequately, realistically, and in balance, evaluates and dynamically composes the available resources. The current fiscal policy in BH does not match that description.

The financial markets and institutions in Bosnia and Herzegovina Globalisation reaches all countries of the world without exception, though to a greater extent in some more-so than in others. The process does not pay much attention to the diversity of individual countries (e.g., their individual characteristics and corresponding special needs). This is particularly the case for smaller economies. More precisely, everything points to the fact that the smaller the country, the less the globalisation process cares for the individual particularities of the country as it imposes a schematised framework. Consequently, for a transition of individual economies to a market economy, several well-defined paths of financial and wider economic infrastructure transformations are typically followed. The main objective of this transformation is quick and effective implementation, to activate an economic mechanism consistently based (as far as possible) on private property and a less-regulated market. The magic word for the transition process is privatisation, and for market functioning is deregulation. The transition process in developing countries is dominated by a relatively small number of players in their financial markets, principally foreign banks. This is achieved either through the privatisation of existing domestic banks, or (though less frequently, at least according to experiences of countries in the South East European (SEE) region) through the establishment of their own subsidiaries. Therefore, with little variation, the result of the transition of the financial structure for countries such as BH and other countries in the region is the bank-centric financial system

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29

dominated by foreign banks operating in the region or beyond (mostly domiciled in Austria, Italy, and Germany). We want to emphasise that this development of the banking industry has brought many benefits. This particularly refers to the development of a modern commercial banking system, which restored the confidence of the population and the businesses, the development of many new products, and a perception of a less risky financial environment. This happened even though banks in transition countries are generally legally separate entities from their parent banks, responsible to their depositors only up to the level of capital that they hold in that particular country. Parent banks are exposed to reputational risk only. Although a country in transition needs to develop its banking sector, it is equally important to develop other financial institutions. However, the share of other financial institutions (e.g., leasing companies, investment funds, insurance and re-insurance, and micro-credit organisations) in the market of these countries is minor, reducing the possibility of adequate competition in attracting funds and creating modern and functional products that would better satisfy the needs of the market. Table 2-11: BH financial sector balance sheet on 31 December, 2013 Balance sheet of commercial bank of BH

25,280.0 million BAM

87.3%

Balance Sheet of Other Financial Institution in BH

3,682.6 million BAM

12.7%

Total

28,962.6 million BAM

100%

Source: CBBH, 2013; Annual Report

As shown in Table 2-11, at the end of 2013, the total assets in the consolidated balance sheet of all the banks in BH were 25.3 billion BAM, 87.3% of the total assets of the BH financial sector. All other financial institutions captured 12.7 percent of the total financial potential. This clearly illustrates the dominance of the banking sector, controlled almost entirely by foreign banks. Given that we have a bank-centric financial system in BH, banks are practically the only place where free financial funds can be invested. This is reflected (at least so far) in the BH stock market, which is very weak, although it is offering a huge number of securities created through privatisation. One might think that it provides great possibilities for broad

30

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investment, but these securities are predominantly symbolic in value and typically never traded. Non-initiation of adequate economic growth made the stock market chronically anaemic, and the GFC more-or-less paralysed it. Furthermore, a very modest offer of financial products (for example in the area of life insurance) directed quantities of domestic funds outside the country (mainly to Austria). That in turn meant that a large amount of high-quality, long-term financial resources ended up outside the country, so that financial markets in BH, especially capital markets, were left without significant resources available for domestic economic development. All this boosts the power and role of banks in BH’s financial market to an even greater extent. The money market does not function in BH in practice. The functioning of the Central Bank of BH (CBBH) is based on the Currency Board Arrangement, which eliminates the possibility of implementing open market operations. However, this is a small part of a larger problem, since open market operations are not the only contributor to the development of the money market. Historically, the money market started as a mechanism for the redistribution of liquidity, especially among banks, and even before that, as a source of short-term funds. But in our general state of disarray and inaction, how would anybody dare to give money for the “promise of payment?” The problem is caused by the weak regulation of an unwilling and ineffective government. The non-functioning money market (even capital markets) can be explained to a large extent by: (1) the unwilling attitude of the regulator to the establishment and implementation of a legal system that makes investors feel safe; (2) the almost complete lack of governmental presence in the money market (except for short-term bridging of the budget deficit) and capital markets for the public offering of securities. It must be said, however, that BH’s entities and even some local communities (municipalities and towns) have recently started issuing securities.

Consequences of the “one-dimensional” institutional infrastructure of the financial market in BH Pros: The commercial banks operating in BH are central financial institutions with the dominant influence on the general perception of the possibilities of development as well as the risk profile of the financial system, individual companies, and investment opportunities. At the same time, banks established with foreign capital provide information on development opportunities in the country to their clients. In particular,

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31

they give advice to their clients, especially foreign investors, on how to adjust to local conditions and optimise their investment aspirations. In this way, they have a critical influence on the development of financial markets in BH, not only through their financial operations but also by informing potential investors and thus creating communication standards with foreign investors. Cons: The banking industry (structured in BH as a quasi-monopoly) determines the level of interest rates. Banks exclusively control the payment system and level of fees (e.g., charging 1.5 BAM for paying bills to service providers who have opened a bank account. What does that transaction actually cost?) The tendency of banks to dominate and monopolize is reflected also in the fact that a draft law on the abolition of the license for payment transactions for the Post Office is currently before the FBH Parliament (as a proposal). Additionally, banks in BH are not consistent in scope, content, or depth in implementing the Vienna Initiative.xxii When global banks first expanded into emerging markets, the idea was that they would bring greater efficiency and foster competition. And there is evidence it did – for a while. But the financial crisis changed that: Faced with the need to deleverage and meet higher capital requirements, they are now reducing their exposure to emerging markets, prompting damaging credit crunches, and using profits obtained from subsidiaries to recapitalise parent banks (Ortiz, 2012).

Ortiz’s message is very clearly seen in the following tables. Table 2-12 shows that the mother banks withdrew 2.38 billion BAM during the Global Financial Crisis (GFC), partially off-set by a reduction of the reserves and by clawing back part of the banks’ foreign assets (1.7 billion BAM). Likewise, in Table 2-13 we can see that during 2008 to 2012, the volume of short-term lending to non-financial private enterprises and households grew steadily, while long-term loans to non-financial private enterprises stagnated, and over 0.5 billion BAM in long-term loans were withdrawn from households. If the supply of short-term funds is well above its demand, as is the case in BH, the short-term interest rate should fall. However, by depositing the short-term assets in the foreign markets, their supply is balanced by the demand and the demand for long-term funds is satisfied too. This maturity transformation is partially responsible for the high interest rate, especially for the short-term loans, which are not the result of the supply and demand for these loans on the domestic, BH market.xxiii This is, in a sense, satisfactory for the “daughter” and “mother” banks, but is not in the

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32

interest of the enterprises and households. This also suggests that extra effort should be devoted to the rapid development of local financial markets and institutions – that may increase competition and allow more efficient use of the funds within countries. Table 2-12: The consolidated balance sheet of commercial banks in BH (an excerpt of selected items, at the end of the period, in million BAM) ASSETS

LIABILITIES

Year

Reserves (A)

Foreign Assets (B)

Ȉ(A+B)

2006

3,063.6

2,357.1

5,420.7

4,074.8

2007

4,022.9

3,558.6

7,581.5

5,165.7

2008

3,393.3

3,106.1

6,499.4

6,311.9

2009

3,632.0

3,190.3

6,822.3

5,744.1

2010

3,679.8

2,814.2

6,494.0

4,783.2

2011

3,469.7

2,724.5

6,194.2

4,176.9

2012

3,370.4

2,502.2

5,872.6

3,931.6

ǻ1,708.9

ǻ -2,380.3

Total

Source: CBBH Bulletin no.4 (2012)

Foreign Liabilities

Bosnia and Herzegovina: What’s Next?

33

Table 2-13: The structure of short-term and long-term loans from commercial banks by sectors (an excerpt of selected items, at the end of the period, in million BAM) SHORT-TERM LOANS Loans to nonfinancial private enterprises

Loans to households

LONG-TERM LOANS

Total

Loans to nonfinancial private enterprises

Loans to households

Year

Total

2006

2,068.8

1,453,4

466.6

7,130.4

2,592.7

3,893.0

2007

2,552.7

1,819,0

564.5

9,298.7

3,439.2

5,104.4

2008

3,439.0

2,579,8

645.7

11,070.5

4,142.2

6,051.1

2009

3,399.7

2,459,8

716.4

10,650.4

4,186.9

5,590.8

2010

3,626.5

2,624,0

801.9

10,916.9

4,309.5

5,522.3

2011

3,984.0

2,935,2

858.4

11,327.1

4,186.7

5,846.4

2012

4,263.8

3,178,1

910.8

11,682.3

4,263.7

5,883.9 ǻ -528.8

Source: CBBH Bulletin no.4 (2012)

Conclusions and recommendations The primary of aim of transition, with privatisation as its core, is to transfer state capital, social capital, and public property into private ownership. The initial accumulation of private capital is the foundation for the consistent development of the market economy. Transition, especially privatisation, is a highly complex process, and privatisation leads to strong social stratification even in an ethnically homogeneous country. Bosnia and Herzegovina has an ethnically diverse population, with the potential for social, political, and economic division to express itself as nationalism, and in so much evidences an extra risk over and above those present in its neighbouring, transitioning countries. Nationalism is more likely to emerge and escalate in a poor country like BH, and dealing with potential or actual nationalism is an extremely difficult and very delicate problem. Even with all the risks, transition and development must be accelerated. BH has high structural unemployment, little or no growth, and largely unused, potential resources. Without rapid and well-planned transition, BH

34

Chapter Two

will fall into even greater difficulties. Fluent and efficient functioning of the market economy depends on the development of powerful and functional institutions and on consistent, coherent, and well-respected implementations of law. This is the only way to reduce the uncertainty and risk perception of potential investors. The Central Bank of BH is an institution that works well. Its management of the Currency Board Arrangement contributes strongly to the country’s macroeconomic stability. Fiscal policy in BH is decentralized, but is irresponsibly implemented by both governments and parliaments. I believe that an efficient way to improve this is the introduction of a Fiscal Discipline and Sustainability Strategy (FDSS). FDSS would not only be a strategy, but would establish a set of binding rules. The result would be to reduce spending on salaries and transfer expenditures, and to increase capital expenditure. This is possible only if the fiscal policy is strongly aligned to the objectives of an appropriate development strategy, aimed at a realistic, balanced evaluation and utilisation of the available resources. Strong support should be given to education and science, food production, the development of tourism, re-industrialisation, and trade within the countries in the region, and then with the EU. The governments at various levels of the decentralised state authority could provide additional funds for investment by issuing debt. This could in turn increase the liquidity in the financial markets. If we succeed in creating confidence and liquidity on the financial markets, more companies will join over time. Potentially intensified development of financial markets in BH could in turn stimulate further macroeconomic stability and development.

References Bosnia and Herzegovina. (1996). Statistiþke informacije Bosne i Hercegovine 1990., 1991. i 1995, godine, juli / srpanj 1996. Sarajevo: Zavod za statistiku Bosne i Hercegovine. Central Bank of Bosnia and Herzegovina (2013). Annual Report. —. (2013). CB BH Bulletin no. 4. —. (2003). CB BH Bulletin no. 4. ýauševiü F. (2013): Bosanska ekonomska enigma, O tranziciji od 1996 do 2013 (The Bosnian economic enigma About transition from 1996 to 2013). In Forum Bosnae (No 63-64). Sarajevo: Meÿunarodni forum

Bosnia and Herzegovina: What’s Next?

35

Bosna. European Bank Coordination (EBCI) (2014). Vienna Initiative. Retrieved from website http://vienna-initiative.com/ European Bank for reconstruction and Development (EBRD) (1999). Transition report. Hrvatska narodna banka (2013). Bilten 198. prosinac 2013 International Monetary Fund (IMF) (2002, August). IMF Approves US$89 Million Stand-By Arrangement for Bosnia and Herzegovina, Press Release no. 02/35, August 2, 2002 Kreso S., & Begoviü S. (2012, May). Maturity (mis)matching in currency board (like) regimes. Interdisciplinary Management Research, 8, 423438. Retrieved from http://www.efos.unios.hr/interdisciplinary-management-research/wpcontent/uploads/sites/27/2013/05/interdisciplinary_management_resear ch_viii_2012.pdf Kreso S., & Lazovic-Pita L. (2013, May). Is fiscal discipline and sustainability strategy (FDSS) an appropriate option for BH?. INTERNATIONAL Conference The Changing Economic Landscape (6; 2013; Pula). The Changing Economic Landscape: Issues, Implications and Policy Options: conference proceedings of the 6th International Conference, Pula, 30.05.-01.06.2013. / . –Pula: Juraj Dobrila University of Pula, Faculty of Economics and Tourism “Dr. Mijo Mirkoviü”, 2014. Kreso S. (2012). Globalizacija I promjena focusa makro ekonomsko guprav ljanja (Globalisation and the changes in focus of macroeconomic management). Sarajevo: Ekonomski fakultet u Sarajevu. Ortiz G. (2012, March 4). Emerging markets must lead banking reform. Financial Times. Retrieved from http://www.ft.com/cms/s/0/80da1a4e6486-11e1-9aa1-00144feabdc0.html#axzz209kDXsvy (accessed: 09.07.2012.) Rodrik D. (2013). The Past, Present, and Future of Economic Growth (Working paper 1, June 2013, Global Citizen Foundation). Retrieved from http://www.law.nyu.edu/sites/default/files/upload_documents/GCF_Ro drik-working-paper-1_-6.17.131_0.pdf (accessed: 09.03.2014.) Organisation for Economic Co-operation and Development (OECD). (1998). OECD Economic Surveys: Yugoslavia 1987/1988. Paris: OECD Publishing. ISBN: 9264131183, 9789264131187 The World Bank (1996) Bosnia and Herzegovina – Toward Economic Recovery (Country Study) Washington, DC: The World Bank.

36

Chapter Two

(1997). Bosnia and Herzegovina - From Recovery to Sustainable Growth (Country Study). Washington, DC: The World Bank. The World Bank, WDI (World Development Indicators). Retrieved from: http://data.worldbank.org/data-catalog/world-development-indicators

Notes i International Conference on Economic and Social Studies. The theme was “Regional Economic Development”, 24–25 April 2014. International Burch University, Sarajevo, Bosnia and Herzegovina. ii

Table 4.1 Economies That Grew by at Least 4.5 Percent a Year per Capita over a Period of 30 Years or More.

iii

The decisive momentum, before the war started, was the 14th Extraordinary SKJ Congress, 20–22 January 1990, in Belgrade. Around midnight on January 22 1990, Congress was discharged and SKJ (the successor of the famous Communist Party of Yugoslavia) vanished as a political integrating force – and thus disappeared the main pillar of Yugoslavia. iv

Which showed clear and very strong elements of aggression against Bosnia and Herzegovina. v

If we count the newly formed Republic of Kosovo, there are seven.

vi

See more in: ýauševiü F. (2013).

vii

For example, China recognized this need and announced its reforms in 1978 (Deng Xiaoping). These reforms intensified in 1985, and the West “retaliated” by launching globalization. See more in: Kreso, S. (2012, Appendix 1.1.3: Deng Xiaoping's “Four modernizations”). viii

In WWII, Bosnia and Herzegovina was the scene of the biggest operations and greatest suffering in the whole of Yugoslavia. The same statement is true for the war of 1992-1995 at the time of the dissolution of Yugoslavia. BH’s neighbours all had clearly expressed ambitions to divide BH among themselves.

ix

“The government of...” and “The Republic of Bosnia and Herzegovina” had been the official names of government and country at that time, but these names were modified under the provisions of the Dayton Agreement and the BH Constitution. “Article I: Bosnia and Herzegovina: Continuation. The Republic of Bosnia and Herzegovina, the official name of which shall henceforth be “Bosnia and Herzegovina,” shall continue its legal existence under international law as a state...; Article V: Presidency: ... Council of Ministers. The Presidency shall nominate the Chair of the Council of Ministers, who shall take office upon the approval of the House of Representatives. The Chair shall nominate a Foreign Minister, a

Bosnia and Herzegovina: What’s Next?

37

Minister for Foreign Trade, and other Ministers as may be appropriate, who shall take office upon the approval of the House of Representatives. Together the Chair and the Ministers shall constitute the Council of Ministers, with responsibility for carrying out the policies and decisions of Bosnia and Herzegovina in the fields referred to in Article III(1), (4), and (5) and reporting to the Parliamentary Assembly (including, at least annually, on expenditures by Bosnia and Herzegovina).” The General Framework Agreement for Peace in Bosnia and Herzegovina, (Initialled in Dayton on 21 November 1995 and signed in Paris on 14 December 1995). http://www.oscebih.org/dejtonski_mirovni_sporazum/EN/annex4.htm#ArticleIBos niaandHerzegovina Comment: In the Dayton Agreement, the Constitution for BH is written: “Bosniacs, Croats, and Serbs, as constituent peoples (along with Others), and citizens of Bosnia and Herzegovina hereby determine that the Constitution of Bosnia and Herzegovina is as follows...” (Dayton Agreement and the Constitution for BH), http://www.oscebih.org/dejtonski_mirovni_sporazum/EN/annex4.htm A glance at the Constitution of the United States signally fails to reveal a similar clause, which might have read, “Indians, Anglo-Saxon, Germans, Italians, Chinese, as constituent peoples (along with Others), and citizens of the United States of America hereby determine that ... [something in the United States] shall be regulated as follows:”. Many of the creators of the Dayton Agreement, authors of the Constitution for BH, were US citizens who would have been horrified to see such a clause in their own Constitution. We can understand that BH was, strategically, the best place to spend all the negative energy of Yugoslavia’s dissolution and to break the illusions of possible creation of a client state of the East or the West. We can also understand that, when the great powers understand each other poorly, the fulcrum of their politicaleconomic seesaw rests on BH’s mountains. What we, who paid such high prices in a deadly war, cannot understand is why we are saddled with a Constitution beyond all known standards of the world’s democratic societies; a Constitution where the constituent peoples, not the citizens, are in the foreground; a Constitution so complicated and functionally expensive that we feel additionally penalized simply because we survived our own suffering. x Bosna i Hercegovina, Zavod za statistiku Bosne i Hercegovine, Sarajevo, Statistiþke informacije Bosne i Hercegovine 1990., 1991. i 1995. godine, juli / srpanj 1996.godine. xi

Table 1.2, Bosnia and Herzegovina – From Recovery to Sustainable Growth (World Bank, 1997, p. 17)

38

Chapter Two

xii

The international community was fully aware of the need for appropriate and effective implementation of PRP. This can be seen from the following official opinion of the World Bank, in a document prepared for the 2nd donors’ meeting in support of Bosnia and Herzegovina, held in Brussels on 12-13 April 1996: “Without a durable peace, Bosnia will remain troubled and potentially unstable, and blight the prospects for a peaceful future and economic progress for all the countries of the Balkan region ... The economic reconstruction and recovery have become the focal point for both policy makers and the public; the outcome could cement or shatter the ongoing peace process.” Bosnia and Herzegovina: Toward Economic Recovery (World Bank, 1996, pp ix, xiii). When we read this in the official documents of International Community, then we really have to ask why they did not plan better and do more, especially in the first phase, in the implementation of PRP. Was it not worthwhile to invest enough to avoid the threats that they themselves pointed out? I am almost afraid to search for the answers. xiii In this regard, we recall the time of the Highland Clearances. Big landowners (mostly the aristocracy) chased small tenant farmers off the land, destroying their houses, so they could graze thousands of sheep on the poor land. That's what happened in England as a "prelude" to the Industrial Revolution. xiv

This is a crucial issue for further progress in BH today. One of the main reasons for the dissolution of Yugoslavia was that its development was based on an excessive role for individuals (especially President Tito) rather than on the promotion and development of institutions. Any individual, no matter how powerful, is mortal. An institution transcends the death or retirement of any of its members and therefore has a much greater stabilizing influence on a country or group of countries.

xv

Through the PRP, the international community restricted the grant of loans to DEM/BAM 300,000, putting large companies (according to the financial terms) outside the scope of the PRP.

xvi

See, for example “Do granice i nazad: Tuzlanski radnici se vratili kuüi, ali poruþili: ‘Ovako neüe završiti!’” (“To the border and back: Tuzla workers returned home, but sent a message: ‘This is not the end!’”), Žurnal on-line magazine, http://zurnal.ba/novost/18593/do-granice-i-nazad-tuzlanski-radnici-se-vratili-kuciali-porucili-ovako-nece-zavrsiti Graniþna policija ne dozvoljava kolektivan odlazak radnika iz BiH (Border Police prevent the collective exodus of workers from Bosnia and Herzegovina), Headline in Klix, on-line magazine, http://www.klix.ba/vijesti/bih/granicna-policija-ne-dozvoljava-kolektivan-odlazakradnika-iz-bih/141228016

xvii I think that the International Community, driven by economic ideas of neoliberalism (globalization), was inclined to favour the decay of large companies. In

Bosnia and Herzegovina: What’s Next?

39

their eyes, these companies were strongholds of the ideology of self-management socialism, state/group ownership, where the international community saw private businesses and private capital as a good foundation for the nations they were advising. Renewal of the large companies would rekindle the old ideology, a backward step as far as the International Community was concerned. The way to avoid it was to privatize the large companies before restoring them. That would cut the links between employees (who had “owned” the company in the days of selfgoverning socialism) and the company itself. To achieve that goal (and others already mentioned), it was necessary that the dinosaur companies should fail. xviii

Employment Service of Bosnia and Herzegovina, http://www.arz.gov.ba/statistika/mjesecni/default.aspx?id=1455&langTag=bs-BA, access on 21/04/2014 The Agency for Labour and Employment (17/12/2013): In September the registered unemployment rate was 44.8 per cent; there were 554,929 persons unemployed in BH. Unemployment rate calculated by the ILO is significantly lower than registered, and in BH it amounted to 27.5 percent, about 310,000 individuals. http://www.oslobodjenje.ba/ekonomija/aaccess ongencija-za-rad-i-zaposljavanjebih-u-septembru-448-posto-nezaposlenih, access on 21/04/2014 xix

See more in: Kreso and Lazovic-Pita (2013).

xx

Political instability and unfinished transition and privatization in BH mean that monetary policy has to be conducted on the principle of the CBA. xxi It is very important to understand that all the components of the economic policy of a country have to be devoted to macroeconomic stability as well as development. However, monetary and fiscal policies are the two most influential mechanisms. xxii “The European Bank Coordination “Vienna” Initiative is a framework for safeguarding the financial stability of emerging Europe. The Initiative was launched at the height of the first wave of the global financial crisis in January 2009. It brought together all the relevant public and private sector stakeholders of EU-based cross-border banks active in emerging Europe, which own much of the banking sectors in that region and also hold a significant part of government securities” (EBRD, 2012) http://vienna-initiative.com/ xxiii

See more in: Kreso and Begoviü (2012).

CHAPTER THREE PROGRESS OF THE TRANSITION IN THE SOUTHEAST EUROPEAN COUNTRIES WIOLETTA NOWAK

Abstract: The aim of the chapter is to analyse the progress in transition of nine Southeast European countries (Albania, Bosnia and Herzegovina (BH), Bulgaria, Croatia, Macedonia (FYROM), Montenegro, Serbia, Slovenia and Romania) during the period 1998-2012.The Wroclaw taxonomy method is used to establish similarities and differences in the evaluation of the progress in transition achieved by the examined countries. The study is based on six indices used by the European Bank for Reconstruction and Development - EBRD (large scale privatisation, small scale privatisation, governance and enterprise restructuring, price liberalisation, trade and forex system, and competition policy). According to the evaluation results, Montenegro, Serbia, and Bosnia and Herzegovina experienced the greatest progress in transition towards an open market-oriented economy during the analysed period. The following pairs of countries: SloveniaCroatia, Bulgaria-Romania and Albania-FYROM showed the smallest differences in the evaluation of the transition. In the case of such countries as BH, Montenegro and Serbia there are not many similarities in the evaluations of their transition to market economy. Keywords: transition, Wroclaw taxonomy method, EBRD, Balkan region

Introduction At the beginning of the 1990s, Southeast European (SEE) countries started their transition towards a market economy. Some countries implemented radical transition policies and others were late and slow in market reforms (Koáodko and Tomkiewicz, 2009). As a result, countries

Progress of the Transition in the Southeast European Countries

41

achieved different levels of progress in the transition towards an open market-oriented economy. The aim of the chapter is to analyse the progress of transition within nine SEE countries during the period 1998 to 2012. The study includes the following countries: Albania, Bosnia and Herzegovina (BH), Bulgaria, Croatia, Macedonia (FYROM), Montenegro, Serbia, Slovenia and Romaniai.The analysis is based on six indicators which the European Bank for Reconstruction and Development (EBRD) uses to evaluate progress in transition in its countries of operations. The indicators are the following: large scale privatisation, small scale privatisation, governance and enterprise restructuring, price liberalisation, trade and forex system, and competition policy. Their measurement scale ranges from 1 to 4.33. Transition indicator score 1 represents little or no change from a centrally planned economy and 4.33 represents the standard of the industrialised market economyii. In order to establish similarities and differences in the assessment of the progress in transition achieved by the Southeast European countries the Wroclaw taxonomy method is appliediii. By this method, groups of countries with the most similar EBRD indicators in the period of 15 years are identified.

The EBRD assessment of progress in transition in nine Southeast European countries in the years 1998 to 2012 In 2012, Bulgaria and Croatia achieved the highest average transition indicator score (3.72) within the group of the analysed countries. Romania had an average score 3.67, FYROM and Slovenia achieved the same level 3.56, Albania 3.50, Montenegro 3.28, Serbia 3.17 and BH 3.06. Fifteen years earlier the ranking of the countries according to the average scores was the following: Slovenia (3.44), Croatia (3.39), Romania (3.17), Bulgaria (3.11), FYROM (3.00), Albania (2.95), BH (2.28), Serbia (1.56) and Montenegro (1.28). In the years 1998-2012 the biggest changes in the average transition indicator scores were observed in Montenegro and Serbia. On the other hand, Slovenia made the smallest progress in transition. It is worth noting that the difference between the country with the highest average score and the country with the lowest one decreased significantly over the examined period. Trends of the average transition indicators in the analysed years are presented in Chart 3-1, Chart 3-2 and Chart 3-3.

42

Chapter Three

omania Chart 3-1: Avverage transitionn indicator scorres in Bulgaria, Croatia and Ro over the periood 1998 to 20122

Source: Own calculations baased on the EBR RD data (www.ebrd.coom/pages/reseaarch/economics//data, accessedd 29 December, 2013) Chart 3-2: Avverage transitioon indicator sco ores in FYROM M, Slovenia, an nd Albania in the years 1998 to 2012

Source: Own calculations baased on the EBR RD data (www.ebrd.coom/pages/reseaarch/economics//data, accessedd 29 December, 2013)

Proogress of the Transition in the Southeast S Euroopean Countriess

43

Chart 3-3: Avverage transitioon indicator sco ores in Montennegro, Serbia, and a Bosnia and Herzegovvina over the peeriod 1998 to 20 012

Source: Own calculations baased on the EBR RD data (www.ebrd.coom/pages/reseaarch/economics//data, accessedd 29 December, 2013)

The anaalysed countriies had the highest h levelss of the indiicators of progress in transition inn those areass in which thhe implemen ntation of economic reeforms was relatively r easy y. Albania, B Bulgaria, FYR ROM and Romania shhowed standarrds of the ind dustrialised m market econom my in the area of the price liberaliisation, and trrade and foreeign exchangee system. Croatia andd Slovenia acchieved the highest h levelss of the indicators of progress in transition in the small-scaale privatisatiion, and the trade t and forex system m. Albania annd Croatia beccame memberrs of the Worrld Trade Organisationn in 2000, FY YROM in 2003 and Monttenegro in 2012. Since then the couuntries have automatically y achieved thee score of 4.3 33 in the trade and fforeign exchaange system. Only BH annd Serbia aree not full members off the World Trade T Organiisation. Accorrding to the EBRD, E a small num mber of adm ministered prrices remaineed in BH, Croatia, Montenegroo, Serbia and Slovenia. All these counntries have acchieved a score of 4.00 in the area of o the price liberalisation. O Over the who ole period Albania andd Macedonia had a score of 4.0 in thhe area of sm mall-scale privatisationn. Bulgaria coompleted the privatisation p of small com mpanies in 2006. Progrrammes of small-scale prrivatisation w were almost ready r for implementattion in Monteenegro (3.67),, Serbia (3.677), Romania (3 3.67) and BH (3.0). M More than 50 per cent of statte-owned enteerprises and faarm assets were in privvate hands onnly in Bulgariaa. Albania annd Romania acchieved a score of 33.67 in largge-scale privaatisation. BH H, Croatia, FYROM, F Montenegroo, and Sloveniia privatised more m than 25 per cent of laarge-scale enterprise aassets. In Serbbia, only som me sales of sttate-owned en nterprises were complleted. The anaalysed countrries had the ggreatest problems with governance and enterprise restructuring, and compeetition policy. Only the

Chapter Three

44

European Union members made some progress in promoting corporate governance and a competitive environment. Apostolov (2013) argued that further improvement in the area of governance and enterprise restructuring in the Southeast European countries requires some changes within their current policies of overall transition economy restructuring.

The application of the Wroclaw taxonomy method to the evaluation of the progress in transition in nine Southeast European countries The Wroclaw taxonomy method was developed at the beginning of the 1950s by Wroclawian mathematicians: K. Florek, J. àukaszewicz, J. Perkal, H. Steinhaus and S. Zubrzycki (Florek et al., 1951). The method is used to group similar objects. A set of N objects

X k k

^O1 , O2 , , ON ` with n selected characteristics

1, 2, , n

each is split into typological groups by means of the Wroclaw taxonomy graph. In order to compare objects, a measure of distance is applied. For N objects the matrix of distances has the following form

d12  d1N · § 0 ¨ ¸ d2N ¸ ¨ d 21  ¨    ¸ ¨ ¸ ¨d ¸ © N1 d N 2  0 ¹ where di j ,

i, j

1, 2, , N , is the distance between objects

(1)

Oi

and

Oj

.

Very often the Euclidean metric is used as a measure of distance. It means that the distance between the pair of objects i and j is given by the formula 1

di j

where

zi k

2 ªn 2º «¦ zi k  z j k » ¬k 1 ¼

is the standardised value of

X ik

(2) i.e. characteristic

Xk

of

Progress of the Transition in the Southeast European Countries

z

O

45

X

object i , j k is the standardised value of characteristic k of object O j i, j 1, 2, , N k 1, 2,  , n , , . The standardisation procedure is needed to eliminate the influence of different units of measurement of characteristics, of the analysed objects. The variable the following way

zik

zi k

is calculated in

X ik  X k

Vk (3)

where

Xk

is the mean of characteristics

deviation of

Xk

Xk

and

Vk

is the standard

.

After computing distances for all pairs of objects, the shortest distances are selected and such pairs are linked by line segments. The smaller the distance, the more similar the objects are. Each object (a vertex of the graph) is connected with its nearest neighbour in the set. All objects are connected to single joint graph that can be branching but cannot contain closed chains. The connected graph is the shortest spanning tree. It does not depend on the vertex one starts with. Then P groups of the most similar objects are formed. In order to do this, P-1 longest links are removed from the graph. The number P can be previously determined by the researcher or calculated using various methods (Nowak, 2014). In our case Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYROM, Montenegro, Serbia, Slovenia, and Romania are the objects in the method. More precisely, we deal with 9 u 15 objects because the progress in transition in nine Southeast European countries is analysed in the years 1998-2012. Each country in a given year is characterised by the values of the EBRD transition indicators (large scale privatisation, small scale privatisation, governance and enterprise restructuring, price liberalisation, trade and foreign exchange system, competition policy). In the method, nine objects with six characteristics each are examined during 15 years. The Euclidean distance (2) is used to calculate the distance between each pair of objects. In the case of the EBRD transition indicators, the standardisation of data is not needed.

46

Chapter Three

The Wroclaw taxonomic graph for each examined country is presented in Figure 3-1. While the graph for all countries is shown in Figure 3-2. Figures between vertices (boxes) in Figure 3-1 and 3-2 show the smallest distances between the countries. Among the examined countries Montenegro, Serbia, and Bosnia and Herzegovina experienced the greatest progress in the evaluation of transition in the years 1998 to 2012. In Montenegro, the distance between 1998 and 2012 was 5.31, in Serbia 4.31 and 2.21 in BH. The changes of the EBRD assessment of the transition in FYROM (1.89), Albania (1.70), Bulgaria (1.67), Romania (1.60), Croatia (1.05) and Slovenia (0.47) were considerably smaller than in Montenegro. In Montenegro, the biggest changes of the EBRD evaluation were observed in the years 1998 to 2002 and 2004 to 2007. They followed principally from the improvements in the area of trade and foreign exchange system, large scale privatisation and small scale privatisation. It is worth noting that in Montenegro all the transition indicators (except price liberalisation) were assessed at level 1 in 1998. Similarly the pattern of changes is characterised for Serbia. This country made the biggest progress in the area of trade and foreign exchange system, and price liberalisation in the years 1998 to 2002, and in privatisation in the years 2004 to 2006iv. In BH, the biggest changes in levels of transition indicators took place somewhat later. In the years 2002 to 2003, they followed mainly from the improvements in the area of trade and forex system. In turn, in the period 2005 to 2007 Serbia made progress primarily in competition policy. In Bulgaria, the progress in transition was primarily observed in the years 1998 to 2002. Bulgaria implemented reforms in small and large scale privatisation, and improved competition policy. FYROM accelerated its market reforms in the period 1998 to 2004 and achieved higher scores in competition policy, and governance and enterprise restructuringv. Gradual changes in Croatia and Romania were implied by developments in the area of competition policy, and governance and enterprise restructuring. The progress in transition in Albania in 2000 was implied by positive changes in price liberalisation. Slovenia did not make any real progress in the EBRD assessment of its transition over the period 2002 to 2012. It is the only country among nine analysed Southeast European states that was downgraded in 2012 (in the area of competition policy).

Progress of the Transition in the Southeast European Countries

47

Figure 3-1: The Wroclaw taxonomic graphs for Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYROM, Montenegro, Romania, Serbia and Slovenia in the years 1998-2012

48

Chapter Three

Figure 3-1: continued

Note: A is Albania, BH – Bosnia and Herzegovina, B – Bulgaria, C – Croatia, MK – FYROM, M – Montenegro, R – Romania, S – Serbia, SL – Slovenia. Numbers in the boxes indicate years i.e. 98 stands for 1998– 2000, etc. For example: A98 stands for Albania in 1998, A01-A03 – Albania in the years 2001-2003. Source: Own calculation

Progress of the Transition in the Southeast European Countries

49

Figure 3-2: The Wroclaw taxonomic graph for nine Southeast European countries in the years 1998 to 2012

50

Chapter Three

Figure 3-2: continued

Note: Two parts of the graph are linked by the line segment between vertices MK00-MK02 and M09. Source: Own calculation

Among nine analysed Southeast European countries, the following pairs: Slovenia-Croatia, Bulgaria-Romania and Albania-FYROM showed the smallest differences in the evaluation of the transition over the period 1998-2012. In 2005, Romania reached the same level of six transition indicators as Bulgaria in 2001. Albania received the same assessment of transition in 2008 as FYROM in 2004. In the case of such countries as Bosnia and Herzegovina, Montenegro and Serbia, patterns of the evaluation displayed similarities with different

Progress of the Transition in the Southeast European Countries

51

countries in different years of the analysed period. For instance, distances between Serbia and Montenegro were the smallest in the years 1998 to 2004 and 2008 to 2012. Over the period 2005 to 2007 the Serbian scores most resembled the Bosnian ones. On the other hand, distances between Montenegro and Serbia were the smallest in 1998, 2003 to 2006, 2009 and 2011, between Montenegro and BH in the years 1999 to 2002 and between Montenegro and Albania over the periods 2007 to 2008 and 2010 to 2012. In turn, the scores achieved by BH were the most similar to those of Bulgaria in 1998, to Montenegro in the years 1999 to 2002 and 2007 to 2010, and to Serbia over the periods 2003 to 2007 and 2010 to 2012.

Concluding remarks The differences in market reforms in Southeast European countries in the years 1998 to 2012 were driven by various economic, political and social factors. Bulgaria, FYROM and Romania improved their transition performance primarily due to European Union conditionality. As a result, in 2012 the highest average transition indicator scores were observed in the EU member and candidate countries. Besides, two pairs of countries, Slovenia and Croatia, and Bulgaria and Romania, displayed the smallest differences in the levels of six EBRD transition indicators over the studied period. During the 15-years period the biggest progress in transition towards open market-oriented economy was experienced by Montenegro, Serbia, and Bosnia and Herzegovina. However, it is worth noting that in 1998, Montenegro displayed little progress in transition in 5 areas and Serbia in 4 areas. If a country starts with the lowest assessment then the progress in a given area is more noticeable. Montenegro, Serbia, and Bosnia and Herzegovina, first of all, have to find a more effective way of the privatisation of their state-owned enterprises. Then, they will be able to improve their achievements in the area of governance and enterprise restructuring, and competition policy. Progress in the aforementioned fields may allow them to attract more foreign investments and finally accelerate their economic growth.

Chapter Three

52

References Apostolov, M. (2013). Governance and enterprise restructuring in Southeast Europe. International Journal of Social Economics, 40(8), 680-691. Ceroviü, B., & Nojkoviü, A. (2009). Transition Progress and Growth. 8th International Conference, „Challenges of Europe: Financial Crisis and Climate Change”, 457-470. Florek, K., àukaszewicz, J., Perkal, J., & Zubrzycki, S. (1951). Taksonomia wrocáawska. Przegląd Antropologiczny, 17, 193-211. Koáodko, G.W., & Tomkiewicz, J. (Eds.). (2009). 20 lat transformacji. OsiągniĊcia, problemy, perspektywy. Warszawa: Wydawnictwa Akademickie i Profesjonalne. Mahmutefendiü, T. (2012). Assessment of transition in the Yugoslav successor states. Zbornik Radova Ekonomskog Fakulteta u Istocnom Sarajevu, 6, 17-29. Nowak, W. (2014). Zmiany w strukturze zatrudnienia w województwie dolnoĞląskim w latach 1999-2010, Studia Ekonomiczne, Zeszyty Naukowe Wydziaáowe Uniwersytetu Ekonomicznego w Katowicach, 166(14), 169-179. Panagiotou, R. (2008). FYROM’s transition: on the road to Europe? Journal of Southern Europe and the Balkans, 10(1), 47-64. Tridico, P. (2013). Values, Institutions, and Models of Institutional Change in Transition Economies. Challenge, 56(3), 6-27. Uvalic, M. (2010). Transition in Southeast Europe. Understanding Economic Development and Institutional Change. Helsinki: UNU World Institute for Development Economics Research, Working Paper, No. 2010/41, 1-27. Vujoševiü, M., Zekoviü, S.,&Mariþiü, T. (2012). Post-Socialist Transition in Serbia and Its Unsustainable Path. European Planning Studies, 20(10), 1707-1727.

Notes i

Kosovo is excluded from the analysis because data for Kosovo which cover the period 1998-2012 are not available. Kosovo became a member of the EBRD in 2012. ii

Retrieved from www.eberd.com.

iii

There are a lot of theoretical and empirical studies on progress in transition in Southeast European countries (Ceroviü and Nojkoviü, 2009; Uvalic, 2010; Mahmutefendiü, 2012, Tridico, 2013). Researches present different approaches to

Progress of the Transition in the Southeast European Countries

53

the evaluation of the state of market reforms and progress in transition. Some of them analyse trends of basic economic indicators in transition economies, others construct econometric models. iv

Vujoševiü et al. (2012, p. 1709) claimed that progress in transition in Serbia in the period 2001-2010 was mainly conducted through large-scale and small scale privatisation. For instance, 2285 companies were privatised in the years 20012009.

v

FYR Macedonia became officially an EUROPEAN UNION candidate country in 2005. The acceleration in transition reforms was mainly driven by EUROPEAN UNION conditionality (Panagiotou, 2008).

CHAPTER FOUR TRADE AS A FACTOR OF ECONOMIC DEVELOPMENT IN THE WESTERN BALKANS PREDRAG BJELIû

Abstract: The countries of the Western Balkans are small in size and underdeveloped with their main and dominant trading partner being the European Union. Like most of the developing countries in the world economies, the Western Balkans economies have not significantly benefited from the liberalised trade regime at a global level. These economies have developed their own regional trade integration, the Central European Free Trade Agreement, revised in 2006 (Central European Free Trade Agreement 2006). In this chapter, we are set to analyse the trade performance of the Western Balkan economies and the impact of regional trade integration on their development. We point out the problem of the competitiveness of these economies as an obstacle to European Union integration. Key words: The Western Balkans, international trade, competitiveness, Central European Free Trade Agreement-2006.

Introduction Trade is understood to be a tool of economic development over a long time. Economic theories suggest that trade is beneficial to all parties that are involved in this economic activity and can contribute to economic development. There are some differences when we account for the size of a country since smaller countries are more dependent on international markets than large ones. The predominant mode of trade integration, apart from multilateral liberalisation in GATTeWorld Trade Organisation system, is regional trade integration. In one of the pioneering works in this field, Jacob Viner stresses that the issue of regional trade integration has united

Trade as a Factor of Economic Development in the Western Balkans

55

all economists; those liberal as well as those protections oriented. All papers suggest that regional trade integration is beneficial for all countries involved in the integration. But some authors, such as Richard G. Lipsey,i point to some conditions connected to the rise of welfare in regional trade integration. Regional economic integration will raise the welfare of its members if those countries have significantly traded before the establishment of this integration. We will focus on trade as a tool of development of the Western Balkan economies and on the perspectives of their regional trade integrations.

The Western Balkans’ economic performance The countries in the South-East Europe that are not European Union members, usually referred to as the Western Balkans,ii are small and underdeveloped countries which are still in transition towards a full market economy. All of these economies were faced not only with economic restructuring after the 1990s but were exposed also to political conflict and unrest. The world economic crisis has affected the Western Balkans through diminishing trade and investments from the European Union, as the region’s most important economic partner. The Western Balkan Countries have low living standards, as measured by World Bank gross domestic product per capita indicator. The lowest one is recorded for Kosovo, around 3,600 USD in 2012, while most other economies in the region have recorded the value in the interval 4,0005,200 USD. The highest Gross Domestic Product per capita in 2012 was recorded in Croatia which is today the European Union’s newest member. Gross domestic product generation in the Western Balkans is more related to services than to industry, since industry constitutes on average of around 25% of GDP in 2012, and the process of deindustrialisation is clearly visible. Trade is very relevant for Western Balkan economies as expected for transition economies in this region. But that trade with the world is unbalanced, since imports are much more significant that exports. We can observe that all Western Balkan economies have significant misbalances in their current accounts. The foreign direct investment is not supplementing the trade integration of the Western Balkan economies since net foreign direct investment is very low, except in Montenegro, where foreign direct investment does not go to the productive sectors but largely to real-estate.

Chapter Four

3.600 4,620 7,220 5,280

Kosovo*

FYROM

Montenegro

Serbia

30

23

34

...

29

23

19

27

20

26

20

26

25

16

Industry Value Added* (as % GROSS DOMESTIC PRODUCT) 2010 2012

92.6

102.9

122.2

..

83.4

98.6

Trade to GROSS DOMESTIC PRODUCT** (2010-2012 yearly average) 84.8

- 10.6

- 18.3

- 3.1

- 7.6

- 0.2

- 9.4

- 10.5

Current Account*** (as % GROSS DOMESTIC PRODUCT in 2013)

0.8

14.0

1.0

4.3

2.6

2.0

Net foreign direct investment*** (as % GROSS DOMESTIC PRODUCT in 2013) 7.5

Sources: (*) World Bank, World Development Indicators 2014, Washington, 2014; (**) World Trade Organisation, Trade Profiles 2013, Geneva, 2013; (***) European Bank for Reconstruction and Development, European Bank for Reconstruction and Development Office of the Chief Economist, Regional Economic Prospects in European Bank for Reconstruction and Development Countries of Operations: January 2014, http://www.ebrd.com/downloads/research/REP/rep-1401.pdf, 15.02.2014

13,490

4,750

Bosnia and Herzegovina

Croatia

4,030

GROSS DOMESTIC PRODUCT per capita* (USD in 2012)

Albania

Economy

Table 4-1: Macroeconomic indicators for the Western Balkan economies

56

Trade as a Factor of Economic Development in the Western Balkans

57

The economic development of the Western Balkan economies was slow at the end of the 20th and beginning of the 21st centuries. Some of the economies of the region have even recorded negative growth rates during the period of the World economic crisis. During the crisis, the reduction in trade flows in the region was far less than the drop in the trade with other markets, including the European Union. But during the crisis the structure of Western Balkan exports had changes in favour of primary productsiii which is not favourable to these economies. Table 4-2: Economic growth in transition countries 2011 to 2013, % 2012

2013

2014

1.6

1.5

1.7

Bosnia and Herzegovina

- 0.5

0.8

1.8

Croatia

- 2.0

- 0.7

1.0

Montenegro

- 0.5

1.5

2.0

FYROM

- 0.3

3.0

3.0

Serbia

- 1.7

2.2

1.3

Kosovo*

2.5

2.5

3.5

SEE Average

0.4

2.0

2.1

Countries in Transition Averagev

2.6

2.1

2.8

Albania

Source: European Bank for Reconstruction and Development (EBRD), Internet, http://www.ebrd.com/downloads/research/REP/rep-1401.pdf, p.8, Accessed 16. April 2014

According to the European Bank for Reconstruction and Development data, economic recovery can be expected in 2014 (data in the Table are projections), but with modest growth rates. Not many countries in the world have taken advantage of the global trade liberalisation and growth of the world trade in the second half of the 20th century to develop their economies. The current processes in the world trade, usually referred to as economic globalisation, can provide the condition for intensive economic growth, but only if countries are able to fit into the global system.

Chapter Four

58

Trade in the Western Balkans The Western Balkan economies’ trade sector is not fully developed, which can be regarded as normal for small economies. Their main export market is the European Union. For most of the economies in the Western Balkans the European Union is the dominant trading partner, with the most important partners being Germany and Italy. Table 4-3: Western Balkans trade shares by main markets in 2012 (European Union and Central European Free Trade Agreement 2006) in % Economy

European Union Exports

Imports

Central European Free Trade Agreement 2006 Exports

Imports

Albania

75.5

61.9

12.0

9.2

Bosnia and Herzegovina

57.9

46.9

31.6

25.2

Croatia

58.3

62.4

21.0

6.1

FYROM

62.8

58.4

24.4

11.6

Moldova

46.9

44.5

0.3

0.4

Montenegro

28.7

38.4

61.9

44.6

Serbia

56.0

58.1

27.9

8.2

Kosovo*

20.8

20.6

19.9

17.9

Source: Central European Free Trade Agreement 2006 Trade Portal

The Western Balkan economies have created their own regional trade integration. The process started in 1999 with the initiative that came from the European Union. In 2006 the integration was strengthened with signing of a single regional trade pact – Revised Central European Free Trade Agreement in 2006 (Central European Free Trade Agreement 2006). Croatia and Serbia, as the two largest economies in the region, were leaders in the Central European Free Trade Agreement in 2006, while others, like Montenegro, and Bosnia and Herzegovina, were more integrated in the import side. This integration had a big impact on the reestablishment of trade ties between the former Yugoslav republics and was very important for the countries in the region during the last World

Trade as a Factor of Economic Development in the Western Balkans

59

economic crisis. Croatia in 2013 became a European Union member and is no longer part of the Central European Free Trade Agreement-2006 integration. In Table 4-4, I have presented the most important trade partners of the selected Central European Free Trade Agreement-2006 parties, by their share in total trade of Central European Free Trade Agreement-2006 signatories. I only observed partners with a share larger than 1% in the total trade in 2012. We can see that the Western Balkan economies predominantly traded with the European Union and that there was a lot of intraregional trade among the Central European Free Trade Agreement2006 signatories. Other important trade partners of the Western Balkan countries include Russia, China, country members of the European Free Trade Association, and Turkey. The Republic of Moldova is part of the Central European Free Trade Agreement-2006, but its trade with other Central European Free Trade Agreement 2006 members is insignificant in its exports since it is less than 1% while Russia has a share of 30.3% in Moldovan exports and 15.7% share in its imports, according to 2012 data. Russia is an important partner for Serbia, since it has a 7.4% share in exports to Serbia in 2012 and 10.9% in Serbian imports in the same year. Turkey is a relevant trade partner of all the Western Balkan economies. In our previous research, we have analysed the trade preferences’ influence on trade flows and proved that Serbia has its straditionals trading partners. The general conclusion is that significant trade preference from untraditional trade partners, even asymmetrical to Serbian favour, cannot divert trade from traditional trade partners in the long run. We have proven that Serbia did not trade significantly more with the United States than with its traditional partners, the European Union and the Central European Free Trade Agreement-2006 members, when it has a more favourable trade regime with the U.S.vi But, the trade regime plays a significant role in directing the trade among the economies. We are not living in a world where we have free trade but, rather managed or regulated trade. Economic development is connected to the trade regimes in existence and we need predictable and longstanding trade regimes in order to have a rational investment in a country’s development.

Chapter Four

7.4 5.4

3.5

2.9

2.0

1.5

1.1

1.0

China Turkey

Serbia

Kosovo*

FYROM

Russia

U.S.

Croatia

Switzerland

FYROM

Turkey

Croatia Russia

EUROPEAN UNION 27

Partner

1.0

1.3

3.2

20.0 5.5

65.0

%

Bosnia and Herzegovina (BH)

Turkey

Azerbaijan

Switzerland

U.S.

Serbia

China

BH Russia

EUROPEAN UNION 27

Partner

Croatia

%

1.3

1.5

1.7

2.7

2.8

4.7

7.1 6.2

61.0

Switzerland

BH

China

Ukraine

Croatia

Turkey

Serbia Kosovo*

EUROPEAN UNION 27

Partner

FYROM

%

1.3

1.5

2.2

2.2

2.3

3.8

7.7 5.2

66.1

U.S.

Brazil

Japan

Russia

Albania

Switzerland

China Turkey

EUROPEAN UNION 27

Partner

%

1.3

1.4

1.6

1.9

1.9

2.5

12 3.6

69.6

Montenegro

Ukraine

China

Turkey

FYROM

Montenegro

Croatia

BH Russia

EUROPEAN UNION 27

Partner

Serbia

%

1.4

1.8

2.0

2.7

3.0

3.1

6.7 4.3

59.3

Albania 1.3 Source: European Commission Website, http://ec.europa.EuropeanUnion/trade/policy/countries-and-regions/statistics/index_en.htm, 25/04/2014.

%

66.5

Partner

EUROPEAN UNION 27

Albania

Table 4-4: Most significant trade partners of the Western Balkan economies and their share in total trade in 2012

60

Trade as a Factor of Economic Development in the Western Balkans

61

The trade of the Western Balkan economies is characterised by many negative trends, such as: x The low value of foreign trade, that should be significantly higher for small economies, with especially low value of exports; x The low coverage of imports by exports, i.e. high deficit of foreign trade balance; x The low level of product diversification of trade; x The large share of primary products and, generally, low processed products in exports; x The low share of technology-intensive products in both imports and exports; x The high share of consumer goods in imports. All these trends are the starting point for any sound trade policy creation. But, the trade policy creation process in the Western Balkans is limited by many obligations towards global and regional trade organisations and agreements.

Western Balkan Competitiveness All previous analyses of trade flows indicate that the international competitiveness of the Western Balkan economies on the global market is low and that trade cannot serve as an important tool for economic development. According to the World Economic Forum data, all the Western Balkan economies are ranked in the second half of the global competitiveness Table. In 2013, Montenegro was the best ranked economy in the Western Balkans, at 67th place, followed by FYROM at the 73rd position. Croatia significantly reduced its international competitiveness in the observed period, 2007 to 2013, and it is now at the 75th place on the global competitiveness ranking. Bosnia and Herzegovina and Albania have improved their competitiveness positions over the years but, are still behind other economies in the region. Serbia has the worst ranking in 2013, as compared to the other Western Balkan economies, taking the 101st position.

Chapter Four

62

Table 4-5: The Western Balkan economies’ competitiveness ranked by the World Economic Forum 2007

2008

2009

2010

2011

2012

2013

Montenegro

82

65

62

49

60

72

67

FYROM

94

89

84

79

79

80

73

Croatia

57

61

72

77

76

81

75

Bosnia and Herzegovina

106

107

109

102

100

88

87

Albania

109

108

96

88

78

89

95

91

85

93

96

95

95

101

Serbia

Source: World Economic Forum sGlobal Competitiveness Reports 2008-2014, Davos, Switzerland

Even if some of the countries in the region have improved their rankings over the years, their positions are still low, in comparison with their most important trade partners. This is also indicated by unfavourable product structure of exports of the Western Balkan economies, especially on the EU market. All the economies in the Western Balkans have a strategic goal of entering the European Union. The main economic condition for European Union membership is that candidate countries have functional market economies. The second segment of the economic condition for European Union membership requires that candidate countries can sustain competitive pressures coming from the single European Union market. A great majority of European Union members are highly developed and have competitive economies. It will be very hard for the Western Balkan economies to integrate into a single European Union market when they become EU members if they do not significantly improve their international competitiveness. Our analysis of bilateral trade between the European Union countries and the Western Balkan economies has shown that the Western Balkan economies’ export to the European Union was on the rise as long as asymmetrical trade preferences in favour of Western Balkan economies were present. The trade regime of the European Union towards the Western Balkan economies was regulated by Autonomous Trade Measures introduced unilaterally by the European Union in 2000. These measures

Trade as a Factor of Economic Development in the Western Balkans

63

were non-reciprocal and introduced asymmetrical trade preferences in favour of the Western Balkans economies. With the signing of the Stabilisation and Association Agreements, the symmetry was introduced in the trade regime between the European Union and the Western Balkans so that exports stagnated and diminishedviii and this was a clear result of their uncompetitiveness towards European trade partners. This is a good warning for Western Balkan economies approaching the single EU market where they will have to find their place and withstand the competitive pressures coming from this market. The Western Balkan countries will have to significantly improve their competitiveness before joining the European Union, and the Central European Free Trade Agreement-2006 is the ideal environment in which to work on this matter. These economies will have to find their trade niche within the single European market and learn how to increase their competitiveness as EU members and contribute to European Union competitiveness. The European Union is a global trade player that resorts to a large number of protectionist measures, which distort global trade flows, and Western Balkan economies will have to fit into this unique trade regime. At present, the Western Balkan economies can work on joint projects and products that can be exported globally, with the practice of diagonal accumulation of origin with the European Union being a good example for this. The Western Balkan economies’ competitiveness on the global market is also significantly influenced by the World Trade Organisation (WTO) multilateral trade regime. Some of the countries in the region are still not WTO members and this membership obligation must be in accordance with the Western Balkans’ future EU trade obligations. The precondition for European Union membership is membership in the World Trade Organisation, which is not just important because of the international trade regime that the WTO sets and oversees but also because of the sets of technical agreements in which they lay down basic trade principles. All individual Western Balkan economies also have bilateral trade agreements with different partners, which have to be in accordance with all other trade regimes applied by the Western Balkan economies. When these economies become European Union members, all these regimes will have to change since the EU is a highly integrated trade block under the Common Trade Policy. This will affect the Western Balkan economies’ competitiveness on non-European Union markets. For sound development, it is necessary to ensure predictability and stability of trade regimes.

64

Chapter Four

Conclusion The Western Balkans consists of small and underdeveloped economies with the burdens of political conflict and unrest which affect their economic development and transition to a full market economy. The trade of the economies of the region is small and they are not fully integrated into the global economy. Their trade is unbalanced since their imports are considerably higher than their total exports and this is a clear indicator of their low competitiveness position on the global markets. The dominant trade partner of all the Western Balkan economies is the European Union, and all regional economies strive to be members in this trade pact. But the low competitiveness of the Western Balkan economies towards its European Union trade partner put into question the future incorporation of this region into the single EU market. The structural reforms of the Western Balkan economies have not been achieved and this can be a problem when full symmetry in trade regime with the European Union is introduced. The low position of the Western Balkan economies on the global competitiveness list also raises the question of the Western Balkan economies’ ability to sustain the competitive pressures coming from the single European Union market. In this regard, the Western Balkans economies will need the assistance of the European Union in order to fully benefit from EU membership.

References Bjeliü, P. (2011). Meÿunarodna trgovina. Beograd: CID Ekonomski fakultet. Bjeliü, P. & Dragutinoviü Mitroviü, R. (2012). The Effects of Competing Trade Regimes on Bilateral Trade Flows: Case of Serbia. Proceedings of Rijeka Faculty of Economics - Journal of Economics and Business, 30(2), 267í294. Bjeliü, P., Jaüimoviü, D. & Tašiü, I. (2012). Effects of World Economic Crisis on Export in CEEC: Focus on the Western Balkans. Economic Annals, 196, 71-98 Central European Free Trade Agreement 2006 Trade Portal. Dragutinoviü-Mitroviü, R., & Bjeliü, P. (2013). International Competitiveness and Asymmetry in Trade Regime in the EUROPEAN UNION Integration: Evidence from Western Balkans. The Tenth International Conference: Challenges of Europe: The Quest for New Competitiveness Proceedings.

Trade as a Factor of Economic Development in the Western Balkans

65

European Bank for Reconstruction and Development (EBRD). (2014). Retreived from http://www.ebrd.com/downloads/research/REP/rep1401.pdf. European Commission Website (2014). Retreived from http://ec.europa.EuropeanUnion/trade/policy/countries-andregions/statistics/index_en.htm. Lipsey, R. G. (1960). The Theory of Customs Unions: A General Survey. The Economic Journal, 52, 496-513. Viner, J. (1950). The Customs Union Issue. Carnegie Endowment for International Peace. New York. World Economic Forum. Global Competitiveness Report. Davos.

Notes i

Richard G. Lipsey(1960). The Theory of Customs Unions: A General Survay. The Economic Journal, 52, 496-513.

ii

Economies included in this group are: Albania, Bosnia and Herzegovina, Macedonia, Montenegro, Serbia and Kosovo.

iii

See more: Predrag Bjeliü, Danijela Jaüimoviü and Ivan Tašiü. 2012. 'Effects of World Economic Crisis on Export in CEEC: Focus on the Western Balkans' Economic Annals, 196e2013, January-March Issue, pp.71-98.

iv

This average includes data for Romania and Bulgaria and do not include data for Croatia. v

This data include Turkey.

vi

Predrag Bjeliü and Radmila Dragutinoviü Mitroviü. 2012. 'The Effects of Competing Trade Regimes on Bilateral Trade Flows: Case of Serbia'. Proceedings of Rijeka Faculty of Economics - Journal of Economics and Business, 30 (2): 267í294.

vii

Radmila Dragutinoviü-Mitroviü and Predrag Bjeliü (2013) 'International Competitiveness and Asymmetry in Trade Regime in the EUROPEAN UNION Integration: Evidence from Western Balkans' in: The Tenth International Conference: Challenges of Europe: The Quest for New Competitiveness Proceedings, 2013, Split: Faculty of Economics.

CHAPTER FIVE FOREIGN DIRECT INVESTMENT IN THE WESTERN BALKAN TRANSITION ECONOMIES: FUTURE PERSPECTIVES ELDIN DOBARDŽIû

Abstract: This chapter aims to analyse how political stability or instability may affect foreign direct investment inflow; by creating an index of performance on this variable for each Western Balkan country and relating it to the measure of foreign direct investment performance for a particular country. Also, the chapter analyses the impact of the European Union accession process on the value of foreign direct investment inflow. The integration of the Western Balkan countries, with the aim of liberalising interregional trade (such as a Central European Free Trade Agreement), represents a chance for improving their mutual cooperation and provides the basis for more intensive trade with the European Union countries. Based on analysis of the current Western Balkan political situation, and on the current position in the European Union negotiations, the chapter indicates some factors which determine the potential foreign direct investment flow directions into the Western Balkan countries as well as the specific recommendations for the economic policy makers. Key words: Western Balkan transition economies, foreign direct investment, political volatility, European Union integration

Foreign Direct Investment in the Western Balkan Transition Economies

67

Introduction Foreign direct investment is a crucial component in transitional processes. Foreign direct investment (FDI) does not only provide much needed financial capital for highly indebted transformation economies (Black and Moersch 1997; Manea and Pearce 2001b), but also leads to a cross border intra-organisational transfer of knowledge, managerial and marketing skills, technology and entrepreneurship (Manea and Pearce, 2001b). FDI “promotes the diffusion of new technologies through direct linkages or spillovers to domestic firms” (Altomonte and Guagliano, 2001). FDI has a strong influence on domestic employment through the types of jobs created, regional distribution of new employment; wage levels, income distribution and skill transfer. Hence, FDI can be seen as essential support for transforming the political and economic systems of these countries into democracies and market economies (Resmini 2000; Lankes and Venables 1996, Bevan et al. 2001). These processes of transition have reached an advanced stage in many CEECs (Central and East European Countries). Prices have been liberalised, the privatisation of formerly state-owned enterprises has rapidly progressed and the once closed economies have opened themselves to foreign trade and investment. As the European Union (EU) expands to the east and south, promising new opportunities for foreign direct investment are arising and gaining broader recognition. The Western Balkans, a region comprising of Albania, Bosnia and Herzegovina (BH), Croatia, Macedonia (FYROM), Serbia and Montenegro, is considered by many current and prospective investors to offer opportunities as Europe’s next high growth business location. The characteristics driving investment in this region include the access it offers to a growing market of over 150 million consumers, right on the doorstep of the EU; an expanding network of bilateral free trade agreements (FTAs) under consideration for conversion to a multilateral agreement for the region; a cost-competitive overall operating environment with labour costs as low as about 30-55% of Czech and Hungarian levels in parts of the region; an abundant availability of skilled labour; competence at all levels of the workforce, as marked by professionalism, a strong work ethic, multilingual proficiencies and strong technical education; the local availability of raw materials; a rapidly improving investment climate with strong government commitment and competitive fiscal and incentive regimes and a first-mover advantage to those entering the market at the front end of a growing wave of investment.

68

Chapter Five

The FDI in the new market economies in Eastern Europe (now for New Member States of the EU) is interesting to analyse from several points of view (Redžepagiü, 2008): ƒ The motivations of foreign, mainly European, firms (the share of the FDI, excluding Europe, is lower than 20% of the total) are divided between access to new markets, on the one hand, and regional integration by means of vertical segmentation, on the other. This contributes to the redrawing of the industrial landscape of these economies by specialising them around activities mainly with high added value. In the analysis of flows and the volume of value added via the exchanges between these countries and the countries of the EU15 emphasise well this phenomenon: intrabranch are, initially, mainly characterised by an inter-branch exchange. ƒ The transformation of these economies into market economies could not have taken place without the assistance of foreign capital. Companies with foreign capital contribute in a very significant way to employment, investment, export and the new specialisation of these economies. ƒ The effect of proximity, the “nearshoring”i of the FDI in which the delocalisation of activities is required in order to gain well-known advantages (cost of work, growth of new markets, etc). It appears that the effect of proximity plays such a significant role because of the constraints related to the production of products or services integrated in the production of goods and services in the country of origin. The experience of the six countries that joined the EU between 1973 and 1986, and that of the CEECs, shows that candidate countries for EU accession are able to attract more FDI inflows than non-candidate countries. The prospect of membership and the process of preparing for accession attract more outward and inward investments because foreign investors anticipate the completion of reforms once clear political prospects have effectively guaranteed their implementation (Bevan and Estrin, 2001). The CEECs attracted the largest amount of FDI inflows from 1998 to 2002, when a clear prospect of accession to the EU had been defined. Also, Bulgaria and Romania started increasing their share of FDI when the accession process started in the spring of 1998. On the other hand, more investment allows for improved economic performance which, in turn, stimulates further FDI inflows. This implies that a clear EU accession prospect is the most important factor in continuing the reform

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process and thus attracting FDI. Accession countries are more attractive as a production location because they guarantee access to the European market and protect investors against sudden changes in trade policy and arbitrariness in market policies (Marie-Janine Calic, 2005). The liberalisation of trade in the Western Balkan countries, whose guidelines are defined by the CEFTA agreement, primarily aims at defining the regime under which interregional trade is going to take place and then to open up the way for more intensive interregional trade. With the member states' signing of the CEFTA agreement, the Western Balkan Region has become a zone for the free flow of goods, capital and people. Before 1 January, 2007, and the joining of the European Union by Romania and Bulgaria, the Balkan Region was a market with 55 million consumers. Once the new geopolitical context of the Balkan Region was created, only a reduced market of 25 million people remained. The unresolved status of Kosovo makes it difficult to determine the exact number of states into which this number of consumers can be divided and also threatens the possibility of the stabilisation and progress of the post conflict Balkans. The development that will, in the near future, affect the definition of the Kosovo status will, to a greater extent; determine the guidelines for the further political and economic development of the Western Balkans. The fact is that a low degree of economic development of the countries in the region conditions the non-competitiveness of their export offerings on the world market. Likewise, as a consequence of political instability, this region also shows a negative trend of exportoriented foreign direct investments. The closest neighbours to the Western Balkans (Austria, Italy, Greece, Slovenia, Hungary, Bulgaria and Romania) show a greater interest in business investments in the region than other members of the EU. However, a negative trend in the political and economic developments of the Western Balkan territory can qualitatively reduce the achieved positions of the European Union in international economic relations. In view of all this, it is perfectly clear why the EU shows an interest in the development of this part of Europe and why it often takes an active role in solving debatable political issues and aids the member countries in finding a common interest for a much stronger economic connection and cooperation. The rest of the chapter is organised as follows: Section 1 briefly reviews relevant literature, with Section 2 presenting FDI inflows in the Western Balkans. The impact of FDI is explained in Section 3, while Section 4 explains the effects of political instability on FDI. The final section concludes the chapter.

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Literature Review Over the past fifteen years, there has been a flourish of literature on FDI in Eastern Europe. This is not surprising since foreign capital has played an important role in most countries during their twenty-year transition to market economies. During the first decade of transition, FDI in most of the Balkan Region was low, most probably deterred by the unstable political environment. Since 1991, a number of political processes and events have had negative economic implications for the whole SEE region (Uvaliü, 2003). Political instability in the 1990s has left a deep mark on the Balkan region, and unresolved political problems remain on the agenda. The economic implications of these events have been particularly serious for the countries of the former Yugoslavia, with the exception of Slovenia. The disintegration of the Yugoslav federation led to the break-up of traditional economic and trade links, a very deep recession, delays in economic reforms as well as the integration of most countries into the EU (Uvaliü, 2012 a). After a marked drop in GDP in the first half of the 1990s, the majority of SEE countries continued to have negative growth rates in the second half of the decade. Economic recovery was generally slow, so that by 2011 three countries had still not reached their 1989 GDP level (Serbia, Montenegro and Bosnia and Herzegovina). Integration with the rest of Europe has also been very uneven. Bulgaria and Romania concluded their association agreements with the EU in 1993 and became EU member states in 2007, whilst the other countries were able to deepen their political and economic relations with the EU only after 2000. These features may account for the fact that, in the burgeoning literature on FDI in transition economies, there has been little research focusing on the SEE region. Demekas et al. (2005) note that SEE is a region not comprehensively covered in econometric studies on FDI in transition economies, in part due to the lack of comparable data. Kekiü (2005) analysed trends in FDI in the Balkans during the early 2000s, concluding that the upsurge in FDI had been based on only a few minimal conditions: the restoration of peace and basic security, the beginnings of economic recovery and modest improvements in the business environment. Kekiü also related, in a cross-section gravity model, FDI inflows into the 27 East European countries during 1998-2002 to a number of variables that influence FDI including GDP, wages, the business environment, natural resource endowments, privatisation and geographic distance. Žugiü (2007) claims that there is a direct link between capital inflows, the faster increase of gross domestic product and the export strategy of countries. This link, according to the author, is the

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reason why the strategy of export competitiveness should be precisely coordinated with the strategy for attracting foreign direct investment. Kathuria (2008), who focuses his analysis on the group of five South East European countries (Albania, Bosnia and Herzegovina, the Former Yugoslav Republic of Macedonia, Serbia and Montenegro), argues that since these countries are running large current account deficits, the most obvious reason for their low investment rates appears to be the low domestic level of (private) savings. Therefore, the need to attract foreign investors is evident, as without investment there can be no growth or catching up with developed economies. Additionally, foreign investors are assumed to increase the average productivity of the economic activity they invest in and this, in turn, could foster new investment opportunities.

FDI Inflows in Western Balkan Countries According to Ranieri (2007), the countries of this region possess some common key location advantages which are: x Highly competitive overall cost structure (labour, land and utilities which are cheaper than in new EU member countries). x Labour availability, cost and quality (well educated and experienced workforce, technical expertise). x Strategic location and proximity (Adriatic access and adjacence to both Western and Central Europe). x Local availability of raw materials and supply network (wood, metals, agricultural products). x Improving fiscal and incentive regimes (regulatory, fiscal and tax reforms and investor incentives). Table 5-1: FDI inflows in million USD in the Western Balkans (2000 to 2012) Country Albania Bosnia and Herzegovina Croatia FYROM Montenegro Serbia

2000 143 150

2001 204 130

2002 135 266

2003 178 382

2004 322 490

2005 265 400

2006 300 570

1,085 175 N/A 55

1,407 441 N/A 186

591 78 N/A 502

2,025 96 N/A 1,197

899 156 N/A 775

2,000 97 N/A 2,020

1,200 200 2,000

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Country Albania Bosnia and Herzegovina Croatia FYROM Montenegro Serbia

2007 659 1,818

2008 974 1,025

2009 996 149

2010 1,051 324

2011 1,038 380

2012 957 633

5,041 693 934 3,439

6,220 586 960 2,955

3,339 201 1,527 1,959

432 212 760 1,329

1,502 468 558 2,709

1,251 135 610 352

Source: World Investment Report, 2013

The Western Balkan countries received significantly less FDI than the CEECs. The political and economic uncertainties in the Balkans undermined the attractiveness for international investors. FDI inflows were generally very low until 2000, with the important exception of Croatia, which received higher amounts of FDI from 1997 onwards. During the first half of the '90s (1989 to 1996), the cumulative net inflows into four Western Balkan countries amounted to only 900 million USD, which corresponded to 2.1% of the total FDI inflows into the 27 transition economies. During the period between 1989 and 2001, SEE-5 reached a share of only 6.3% (9,170 million USD) (Uvaliü, 2003). More than half of the cumulative FDI inflows in the Western Balkans were intended for Croatia. FDI in the Western Balkans was mainly attracted through privatisation issues. For example, one-third of FDI in Croatia in 2000 and two-thirds of the inflow in Albania in the same year were generated by the sale of a bank and the award of a mobile telephone license. In 2001, the sale of the state’s stake in the FYROM national telecom operator generated as much FDI as in the preceding ten years (World Bank, 2001). There was a small share of export-oriented foreign investment in the region. Regarding the structure of FDI, there was not much difference between the CEEC and the SEE-5, with the most attractive sectors being manufacturing (with the clear dominance of domestic market oriented industries like breweries and tobacco), financial intermediation, the trading sector, telecommunication and transport. Investments in these sectors contributed significantly to the efficiency of resource allocation, but insignificantly to the generation of sustainable growth (Zakharov and Kusiü, 2003). Even though this region made a lot of effort to attract FDI during the previous years, it is evident that a higher level of FDI flow into the Western Balkans could be achieved. This depends on the improvement of the overall climate for private activity (private sector development, the legal and regulatory framework for business, progress in privatisation, the development of small and medium-size enterprises and the deepening integration into the EU). The successful FDI performance of the CEECs

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during their preparation for EU accession in the last decade and the experience of the earlier EU enlargements show that economic integration can significantly contribute to an increase in FDI inflows. Since the regional distribution of FDI within the SEE region has somewhat changed in recent years, it is of interest to look at the annual FDI inflows from 2004 onwards. The differences in FDI inflows among the SEE countries, as well as annual variations, have been striking. Under the impact of the global economic crisis, most SEE countries have registered a fall in FDI since 2007-8. In Croatia, FDI also started declining after 2008, to 1.5 billion USD in 2011. It is presumed that the global crisis has also affected developing countries through the decrease in foreign direct investment. Data in the Table 5-1 show a decrease of FDI for most of the countries of the Western Balkans. The only exceptions are Montenegro and Albania where, in 2009, the FDI growth rates were positive (61% and 12% respectively). Decreasing FDI in the region followed the general world trend of FDI during the crisis years. In the world economy, FDI fell about 16% during 2008 and an even more drastic 37% in 2009, while in developing countries the decline in 2009 was about 24%. Data in the lower part of Table 5-1 show an even more significant decrease of FDI for some of the Western Balkan countries, such as Bosnia and Herzegovina (-71%), Croatia (-63%) and FYROM (-60%). Serbia also registered a fall in FDI inflows during the period between 2006 and 2010 (Table 5-1, lower part), but a strong increase in 2011, when FDI inflows almost doubled (to 2.71 billion USD). Please note that the “telecommunications” sector has been renamed “ICT” to reflect methodological changes as of 2011, which have broadened its scope. Table 5-2 shows the transition scores for 15 sectors in all Western Balkan transition economies. The Energy sector policy emerged as one of the toughest policy areas in the transition region. The need for enhanced energy efficiency, investment in renewable energy and cost-reflective tariffs is well recognised but politically difficult to implement, particularly under economic and social pressures. As a result, political interference in the energy sector and reform reversals have become more common occurrences. As with energy, reforms in the infrastructure sectors are complicated, given that tariff adjustments can widely impact various sections of the population. Railway reforms, for example, have proven to be a particular challenge. However, there is often scope to improve service delivery by bringing in private sector finance and expertise, while also easing fiscal burden on the state. Experience suggests that reforms at the

Chapter Five

Agribusiness

3

3-

3-

3-

2+

3-

Country

Croatia

Bosnia and Herzegovina

Serbia

FYROM

Montenegro

Albania

Corporate sectors

2+

2+

3

3-

2

General industry 3+

3-

2+

3-

3-

2-

Real estate 3+

3+

3+

4-

3

2+

4

ICT

Table 5-2: Sector-level transition indicators, 2013: overall scores

74

3-

3+

2+

2

2

Natural resources 4-

Energy

3+

2

2+

2+

2

Sustainable energy 3-

2+

2+

3

2+

2+

3

Electric power

2

2+

2+

2

2+

Bosnia and Herzegovina

Serbia

FYROM

Montenegro

Albania

3-

3

3-

3-

2+

3+

Urban transp.

3-

2+

3-

3-

3

3+

Roads

2

2+

3-

3

3+

3-

Railways

3-

3-

3-

3-

3-

3+

Banking

2

2+

3-

3

2+

Insurance and other financial services 3+

Financial sectors

2-

2+

2-

3-

2

3

Capital markets

1

1

1

2-

2-

3-

Private equity

75

Source: EBRD, 2013

Notes: The transition indicators range from 1 to 4+, with 1 representing little or no change, relative to a rigid centrally-planned economy, and 4+ representing the standard of an industrialised market economy. For a detailed breakdown of each of the areas of reform, see the methodological notes in the online version of this transition report. Upgrades and downgrades are highlighted by upward and downward arrows respectively. A colour code is used for ease of recognition: green indicates a sector that is at a fairly advanced stage of transition, scoring 3+ or higher; conversely, dark red denotes sectors where transition has barely advanced and the score is 2 or lower.

3+

Wastewater

Croatia

Country

Infrastructure

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municipal levels, which tend to be less politicised, are often more successful than those at the national level. Despite the turbulence of the last five years, financial sector reforms have generally remained intact, although with notable exceptions. There is significant scope for further reform and development, especially in the insurance and other financial services sectors, and in private equity and capital markets. It is in these areas, rather than in the banking sector, that changes to scores and assessments have occurred recently.

Impact of Foreign Direct Investments What has been the impact of FDI for the long-term economic development of the individual SEE countries? To what extent have foreign investors contributed to gross fixed capital formation, GDP growth, structural changes, exports and employment generation in the host countries? Throughout the transition region, foreign capital has been an important supplement to domestic savings and in so much has greatly contributed to financial accumulation during the past twenty years. In the transition region, the ratio of FDI to gross fixed capital formation has tended to be higher than the world average and has increased over time (Kalotay, 2010). Using three-year averages, due to large fluctuations in data, Kalotay shows that the ratio for the whole transition region increased over the '90s, reaching a peak of 16% in 2000, but fell under 10% in 200204, before again exceeding 10% in 2005 and 2006. However, his analysis does not include BH, Montenegro and Serbia due to missing data for a large part of the analysed period. Recent data suggest that FDI has contributed quite substantially to gross fixed capital formation in all the SEE countries from 2003 onwards. During the 2003-11 period, the ratio of FDI to gross fixed capital formation was, on average, 32% for the whole SEE region, but was particularly high in Serbia (over 30%), Bulgaria (over 50%) and especially Montenegro (over 70%). As a result of lower national savings and investment in SEE, FDI played a much more important role in the Balkan region than in the CEE and Baltic states, where annual FDI inflows over the same period represented, on average, 17% of gross fixed capital formation. FDI has played an important role in enterprise restructuring in the whole transition region during privatisations, greatly strengthening the private sector and contributing to structural changes. Industrial restructuring usually tends to accelerate when privatisation involving FDI is implemented, frequently creating a dichotomy between modern, foreign owned enterprises and traditional industries. The dominant view has been

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that FDI has had positive spill-over effects for the whole economy, although there have also been findings that run counter to such optimistic conclusions (Mencinger, 2003). Kalotay (2010) convincingly argues that the contribution of FDI to structural changes in various groups of economies in transition has been very uneven; having created strong structural changes only in the new EU member states, but much less so in the Balkan countries. In the Western Balkans there were substantial delays in privatisation in most countries. Privatisation methods during the '90s were based mainly on sales to privileged insiders, and the composition of FDI in SEE often did not favour industrial restructuring since the dominant part, as reported earlier, went into services rather than into key manufacturing sectors. Due to such a structure of FDI, the Balkan countries were not successful in integrating into global supply chains (Handjiski et al. 2010). Although various services can clearly be involved in supply chains and can be quite important for a country’s exports (the most well-known example is India), their share in overall exports of most Balkan countries, for the moment, is fairly low.

Political Instability and its Effect on FDI Inflows One of the most important aspects of the EU’s enlargement process is a new focus on the democratic transformation of the Balkans. This is not just reflected in terms of establishing formal institutions, and constitutional and legal provisions, but also in the consolidation of substantive democratic processes of checks and balances to ensure the inclusion and participation of citizens as well as the irreversibility of recently established democratic systems. However, although many of the Balkan countries have transformed themselves over the past ten years, much consolidation still needs to be done. Indeed, even if international indices rely on different definitions, they agree that democracy in the Balkans is still a “work in progress”. All Western Balkan countries, except FYROM, have maintained the same regime label since 2003. Likewise, the Bertelsmann Stiftung Transformation Index (2012) indicates that only Croatia and Serbia qualify as “democracies in consolidation”, whereas the other Balkan states may be collectively described as “defective democracies”. They hold relatively free elections but fall short of adequately ensuring political and civil rights, or the effective separation of state powers (see also Diamond, 2002; O’Donnell, 2004; and Merkel, 2004). Here again, the picture is one of relative stability insofar as the democratic status of the countries in the region has remained unchanged since the early 2000s, with the partial exception of Serbia, which moved

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from a defective to a consolidating democracy. Thus, despite the fact that these countries continue to be ruled by elected governments, democratic performance throughout the region has not yet acquired a real positive dynamic. Table 5-3: Effective democracy index for the Balkans (2009) Democratic rights

Rule of law

Effective

index

democracy index**

index Albania

66.66

0.197

13.13

Bosnia and Herzegovina

58.33

0.328

19.13

Croatia*

83.33

0.891

74.25

Serbia

75.00

0.384

28.8

FYROM

66.66

0.592

39.46

66.66

0.576

38.40

Montenegro st

*EU member from 1 July 2013 **The index of effective democracy is at a minimum 0 when either democratic rights or the rule of law are absent, and at a maximum of 100 when democratic rights are both fully present, as well as made effective by an operational rule of law. Source: Rosa Balfour and Corina Stratulat, ‘The democratic transformation of the Balkans’, EPC Issue Paper no. 66, European Policy Centre, Brussels, 2011.

As Table 5-3 indicates, constitutional rights are more or less in place across the Balkans, and the forerunners in the EU integration process (for instance, Croatia, followed by Montenegro and FYROM) are more advanced in the adoption of democratic legislation than the laggards (i.e. Bosnia and Herzegovina). However, apart from Croatia, in all the other countries of the region the rule of law is not robust enough to make existing democratic rights effective. Consequently, the Balkan countries exhibit a clear gap between formal and effective democracy: Albania, and Bosnia and Herzegovina emerge as the most problematic casesii, whereas Croatia fares the best in terms of both the formal and substantive criteria of democracy.

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Investment, including FDI, is a forward-looking activity based on investors' expectations regarding future returns and the confidence that they can place on those returns. Thus, by its very nature, the FDI decision requires some assessment of the political future of the host country. There are two principal risks that the investor faces stemming from political instability in the host country. The first is that domestic instability, civil war or conflict with neighbouring countries will reduce the profitability of operating in the host country because domestic sales or exports are impaired, production is disrupted, or the facility is damaged or destroyed. The other consequence of political instability stems from the fact that it is likely to affect the value of the host country's currency, thus reducing the value of the assets invested in the host country as well as that of future profits generated by the investment (Brada, Kutan and Yigit, 2009). Numerous studies and analyses have tried to answer the question of why foreign investors invest in developing countries and transitional economies. However, all the answers can be grouped into three simple strategies: 1. Better service of existing and new customers. 2. Increase of competition, market share and profitability. 3. Better access to resources. Major factors that influence the generation of FDI in a country are general policy frameworks, specific policies and policies that encourage business and, finally, a variety of economic factors. Policy framework is the first important factor. FDI requires good macroeconomic and legal stability, convertibility of currency, fair privatisation strategies and their visible progress, the readiness of domestic companies to cooperate, appropriate opportunities for the reconstruction of infrastructure and large companies, as well as bilateral agreements for the protection of investments from political risk and the avoidance of double taxation. The second set of factors refers to those that influence business performance such as subjective vicinity, valid and timely acquisition of accurate information about a country, the general political environment, country’s image, administrative procedures when doing business, as well as financial and market privileges. Finally, there is a set of factors, mostly economic in nature, such as labour cost, labour skills, integration prospects, market size and market growth, access to neighbouring and regional markets, natural resources, management skills, quality and cost of infrastructure, etc. These factors can have a decisive impact on the investment decision, such as unpredicted expenditures regarding corruption, efficiency of administration, the good reputation and influence of foreign investors as

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well as a positive climate for foreign investors. There are many potential barriers at a state, regional or company level which can make FDI even more difficult. The most critical are: x x x x x x x x x x

Bureaucracy Corruption Legal and tax environment Inexperienced and incompetent government Political volatility and political risk Regional instability Democratic vacuum Macroeconomic and currency instability Lack of skilled management Poor infrastructure

The link between political instability, and asset markets and investment, has been studied in literature from several angles. One significant strand of literature emphasises the importance of political risk in emerging markets. Robin, Liew and Stevens (1996) show that political risk is a more important determinant of asset returns in emerging markets than it is in developed markets. Bussiere and Mulder (1999), using a sample of 23 countries, conclude that including political variables in economic models significantly improves the ability of such models to explain economic crises. They also find that countries are more vulnerable to financial crises when election results are more uncertain. Another section of literature highlights the relationship between political volatility and the behaviour of stock markets with the, not unreasonable, assumption that the latter is a good mirror of investor reaction to political volatility (Ketkar and Ketkar 1989). There is growing literature on the effects of political stability on economic performance, both from a theoretical perspective and in terms of empirical work (Brada et al., 2006). A documented survey of the link between political volatility and economic performance is provided by Carmingnam (2003). This survey covers both theoretical models and empirical studies, and examines the significance of political risk for investment decisions. There are also other studies that examine the impact of political volatility on economic growth and investment. An increase in political volatility decreases investment and, at the same time, brings about a slowdown of economic growth. There are also some works on the effect of political volatility on foreign exchange markets. These works contend that political volatility causes the decline of a country’s currency and, at the same time, makes its exchange rate more

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unstable (Kutan and Zhou, 1993, 1995). Kutan and Zhou show that the political unrest in Poland during the late '80s and early '90s affected foreign exchange returns. How did the political volatility of the Balkan countries affect their FDI inflows? We will try to explain, using some of the following features. All post-communist countries of Central and Eastern Europe suffered a shortage in FDI inflows due to the effect of the transition, but this shortage in the FDI of the Balkan countries is related to a very specific factor, the impact of political volatility in the region, as based on the decisions of foreign investors. Recently, there has been welldeveloped literature that examines the relationship between the host country’s political volatility and FDI inflows. Bennett and Green (1972), Singh and Jun (1995), Globerman and Shapiro (2002) and Cho (2003) all add measures that reflect domestic political volatility or risk as an important factor of the economic characteristics of host countries. Also, they all find that such risk helps to explain FDI inflows, because an increase in political risk actually reduces FDI. Some other indicators are the rule of law and the investment climate, both of which, to a certain extent, reflect political stability and are significant factors in the determinants of FDI inflows into Balkan transition economies. However, we can find a basic deficiency in these studies, which is that the political risk term that they use mainly refers to domestic political volatility such as strikes, riots, civil unrest, etc. Yet, these studies do not treat the risk measures that reflect external political risk, such as war between countries, foreign trade embargos, economic sanctions, ethnic armed conflicts and neighbouring wars, all of which are of such importance in the Balkan Region. The problem is how to qualify the concept of external political stability. There are also additional sources of instability in the Balkan countries, of which political volatility is the most important (Brada et al., 2006). For example, the sharp drop in Albanian FDI inflows from 1997 to 1999 was a reaction to the crisis caused by the collapse of the financial pyramid schemes in 1997 and 1998, and the Kosovo war of 1999. The same reduction in 1999 FDI can be seen for FYROM. Another important factor is the major change in privatisation policy. In the Balkans, privatisation began in the mid-1990s, while in Central Europe it began at the end of the 1980s. Thus, the decision to push ahead with large privatisation transactions in Albania in 2000, and the change of policy in favour of foreign investors in Romania in 1997 and in Croatia in 1998, is greatly evident. The difference between the FDI for each country of the region is due to the effect of political volatility in the region. The shortage due to political uncertainty is quite large, as the FDI inflows expected if these countries were merely in transition would be a

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multiple of the FDI inflows actually observed. Croatia displays a somewhat different pattern. It initially observed FDI inflows which fell short of what was expected, perhaps reflecting the effects of the breakup of Yugoslavia on FDI inflows. However, from the mid-'90s, FDI inflows exceeded expectations (Brada et al., 2006).

Conclusion FDI has the potential to contribute to self-sustaining economic growth in the Western Balkans, especially in light of declining foreign assistance and persistent current account deficits. Its benefits range from technological transfer to employment opportunities, as well as promoting the export capacity of the host countries. Analysis of the main developments in the region has shown that, although the overall trend is positive, FDI flows have been widely affected by one-off transactions linked to privatisation, especially in the service sector, making it difficult to extrapolate past performance into the future. Indeed, the challenge ahead will be to attract more green-field FDI once the main privatisation investment opportunities are exhausted. Several factors are behind the Western Balkans FDI performance. The markets are undoubtedly small and not yet completely integrated. A fully implemented regional trade area could widen the markets to a size of around 22 million people. Although formal political stability has been restored in all countries, the investors’ perception of the region may still be rather negative, given the political influence on the judiciary and the media, as well as the endemic issue of corruption. On the regulatory side, it appears that the countries of the region have, to varying degrees, all implemented FDI-specific policies which, in theory, provide the necessary guarantees and protection to foreign investors. In practice, however, such policies appear to be ineffective, since they have not been preceded by the more “basic” elements of a friendly business environment such as streamlined business procedures, flexible labour markets and an effective rule of law. These generally “basic” elements are still largely missing and FDI in the Western Balkans is mainly attracted through privatisation issues. Even though the countries of the region possess some common key location advantages, such as a highly competitive overall cost structure, labour availability and strategic location, the flow of foreign direct investments to these countries exhibits large differences. Croatia seems to be the most favourable country compared to others of the Western Balkans, especially given its successful integration into the EU. The current economic environment in the SEE region is exposed to a number

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of political risks and instability which have had the effect of prolonging their progress towards a market economy. In spite of this, during the last few years, the overall image of the region appears to have improved, taking steps towards their ultimate objective, i.e. creating the appropriate economic conditions for future EU membership. The positive attitude of the European Union towards the Western Balkan integration into its structure is reflected in its continual participation in the process of stabilisation and integration. To ensure that the efforts to enlarge European integration give the desired results, it is also necessary to promote the much faster economic development of the Western Balkans. By consistently carrying out the reforms and tasks posed by the transition process, there can be an efficient transformation from planned to functional market economies. In order to realise this goal, of great importance is the adoption of legal norms which aim at improving the general business climate and the creation of a favourable macroeconomic ambiance for the further growth of foreign direct investments and a setting for stable economic development.

References Apergis, N., Katrakilidis, C. P., & Tabakis, N. M. (2006). Dynamic linkages between FDI inflows and domestic investment: a panel cointegration approach. Atlantic Economic Journal. Altomonte, C., & Guagliano, C. (2001). Competing locations? Market potential and FDI in Central and Eastern Europe vs the Mediterranean. LICOS Centre for Transition Economics. Discussion paper 108/2001, KUL, Leuven. Bevan, A.A. et al. (2001). The impact of EU accession prospects on FDI inflows to Central and Eastern Europe. Policy paper 06/01, University of Sussex. Bevan, A.A., & Estrin, S. (2001). The determinants of foreign direct investment in transition economics. Centre for Economic Policy Research, Discussion paper 2638, William Davidson Institute. Bennett, P.D., & Green, R. (1972). Political instability as a determinant of direct foreign marketing investment. Journal of Marketing Research, 9, 182-186. Brada, J.C., Kutan, A.M, & Taner, M. Y. (2006). The effects of transition and political instability on foreign direct investment inflows: Central Europe and the Balkans. Economics of Transition, 14(4), 649-680. Black, S.W., & Moersch, M. (1997). Investment and its financing during the transition in Central and Eastern Europe, Cambridge University

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Notes i

“Nearshoring” means sourcing service activities to a foreign, lower-wage country that is relatively close in distance or time zone (or both). The customer expects to benefit from one or more of the following constructs of proximity: geographic, temporal, cultural, linguistic, economic, political, or historical linkages. Similar terms include nearsourcing and nearshore outsourcing. The service work that is being sourced may be a business process or software development. As with offshore, the term “nearshore” was originally used in the context of fishing and other sea-based activities and was later adopted by the business world. ii

The result for Serbia is rather surprising, given the country’s relatively advanced position. This could be due to the fact that the most recent available data used in creating this index is from 2009 and, therefore, may be outdated in relation to recent events and developments.

CHAPTER SIX THE EFFECTS OF TAX INCENTIVES ON REGIONAL ECONOMIC DEVELOPMENT MINE BINIù AND ELIF AYùE ùAHIN øPEK

Abstract: The aim of this chapter is to investigate the results of tax incentives in Turkey as a device for providing regional economic development. Tax incentives have been undertaken as an economic development strategy in developing and developed countries over the past years. Based upon countries’ regional economic development experiences, Turkey’s strategy for regional economic development has been specifically evaluated. From the beginning of the 1980s, several attempts at tax incentives have been made. In the 1990s, strategies about regional economic development in the context of tax incentives came into prominence. On January 1, 1999, Turkey provided investment allowances which depended on location and type of investment, but the results were not as expected. To eliminate these failures and set up regional economic development through tax incentives, a new tax incentive program was introduced on June 4, 2009. This chapter particularly takes into account for the effects of a new investment incentive plan which was put into effect in Turkey on January 1, 2012. One of the main conclusions of the study is that the use of tax incentives could be limited to the reinforcing of regional economic development. Keywords: Regional development, fiscal instruments, tax incentives, incentives, Turkey

Introduction Incentives for regional economic development have long been used as a tool by governments to encourage investment. Tax incentives which aim to ensure regional development’s main goals direct investment support to lesser developed regions. The main reason for using tax incentives as a

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fiscal tool is to influence the investor and to improve regional economic development. Although tax incentives have been used all over the world since the 1980s, the use of tax incentives in practice is a controversial issue in academic literature. While some studies find an impact on economic development, some studies, especially focusing on the long term, find the opposite. Turkey has implemented tax incentive schemes that reward investors for ensuring economic development. The study consists of two main sections. The first section is theory based. Initially, the concepts of regional development and the development of regional development policies will be considered. Then regional development, the relationship between regional economic development and tax incentives, and regional economic development itself will be reviewed. In the second section, as a country example, Turkey will be evaluated in the scope of tax incentives. In this concept, firstly an overview of the history of tax incentives will be evaluated. Secondly, the new investment incentive scheme, especially regional tax incentives, will be assessed. Thereafter, the effectiveness of regional incentives will be analysed. Finally, the current and potential results of a new incentive scheme, whether it contributes to regional economic development positively or negatively, will be discussed.

The Concept of Regional Development and the Development of Regional Development Policies The concept of regional development can be explained by the term “economic development.” There have been various concepts defining regional development. They can be classified as traditional and new regional policies. In the historical process, models, depending on regional development, have been altered according to economic changes. Post World War II, the regional development models that were applied until the 1960s were exogenous models. The regional development models of the period were closely related to the Ford production system and Keynesian economic policies. These models, prescribing top-to-bottom regional development, rested on the idea of additional employment creation. As a result of stagflation tendencies experienced in the 1970s, the developmental differences between central and peripheral regions increased, many industrial regions had economic difficulties, and new regions appeared. Since the beginning of the 1980s, crucial changes in regional development theories have been realised and the concept of endogenous regional development has been developed (Sakal, 2010, p. 11).

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The 1990s are perceived as a period when the world turned into a single pole, technological developments outpaced industrial society, and a transition to a knowledge society was experienced. Through this period, production- knowledge- and other possibilities sharing oriented networks in regional development came into prominence. In this process, structures named as new industrial locations emphasised reciprocal dependence on local platforms and inter-firm information transfer and gave particular importance to research and development activities. The development focus was to form an industrial cluster that ensured knowledge needed for new products and production processes through social regulation mechanisms. Accordingly, the regional development model concentrated on nonphysical factors in the 1990s and importance was given to building capacity at the firm-, industrial- and regional-levels (Sakal, 2010, p. 16). In the context of all these developments, the new problem of regional development was to develop proper approaches for a regional and local problems map that had become more and more complex. Therefore, the need arose for the development of more comprehensive approaches directed both for the building of regional/local capacity, and for the recruitment of socio-cultural and economic environments. The reflection of the situation on regional policies was the creation of a strategic management and a new-fashion regional policy for regional development (Akpnar, 2004, p. 37). According to this new paradigm, a region was an economic asset in which many unused resources existed and regional development had been realised for the formation of an institutional infrastructure and to encourage the use of unused resources by this infrastructure. In the new paradigm, the following concepts came into prominence: the recruitment of the supply structure of the region, encouraging investors to the region, human capital, social capital, local business culture, information transfer networks, the quality of production factors and systems, learning from regional experiences, and innovation (Kumral, 2006, p. 280). It is seen that with traditional policies, the regional development problem is fully financed with central sources, public investments are directed as a result of the perceptions of economic development and growth, and a regional development strategy is determined as based on the orientation of investments to underdeveloped regions. Governments tried to develop this policy strategy with public support and incentive systembased mediums, and through central government bureaucracy. As the result of the perception of clustering, networks, innovativeness, and human capital on which regional and local management structures are influential,

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new regional development strategies are developing as the models in which governance, transparency, measurability, and strategic planning and performance management techniques are effectively utilised. Table 6-1: The characteristics of traditional and new regional policy approaches Characteristics Objectives

Basic Concepts

Decision MakingImplementation Process

Policy Instruments Type of Support

Traditional Regional Policies Regional equality National economic growth Orientation of investments to under-developed regions Development of infrastructure Industrial location theory Fundamental factors such as production costs and labour supply National macro policies and the selection of some special regions Selection through discretionary power of central government Gradual structure Incentives/Subsidies Direct support, satisfying the basic infrastructure needs

Action Type

Project based, reactive

Spatial Objective Policy Development Method Implementing Institutions

Problematic regions Central and top to bottom

Central governments, provincial organisations of the central government, bureaucratic relations Source: Kara, 2008, p. 55

New Regional Policies Development of regional competitive power Increasing the capacities of regional economies Supporting endogenous growth dynamics Learning region theory, endogenous growth theories, Clustering, networks, innovativeness, human capital Governance based decision making process Non-gradual organisational form

Regional development programs Recruitment of investment climate, hi-tech and knowledge based Strategic plan based, all the regions Local agreement based, collective and bottom to top Local administration, voluntary agencies, private sector, etc. Regional units, semiautonomous units, instead of bureaucracy business administration

In this new concept, the strategies that procure regional development may be divided into two: low and high axis strategies. Low axis strategies are intended to increase competitive power through price-based factors,

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and regions try to affect the price-based competition among firms by adapting strategies such as low labour costs, wages, tax reduction, subsidies and grants. These approaches are still used in regional policies. High axis strategies, on the other hand, are based upon regional level learning, innovation, and the positive attractiveness of space, and focus on issues such as regional identity, culture, institutions, and non-physical region-specific values that are effective in the long run (Kara, 2008, p. 19). It is also possible to assess regional development strategies on the basis of qualitative and quantitative strategies. Quantitative strategies represent more traditional factors such as infrastructure, production, location, economic structure and factor endowment. Qualitative factors are defined as the strategic determiners of competitiveness and consist of factors such as social capital, innovation, public-private sector collaboration and institutional structures (Kara, 2008, pp. 19, 20).

The Relationship between Regional Development and Tax In general, tax is defined as unrequited payment to government, and absolute financial and monetary transfer from the private sector to the public sector under juridical virtue for meeting public requirements (Tanröven, 1989, p. 331). In financing public expenditures, basic taxes may have crucial effects on the economic behavior of people. Furthermore, governments may use taxes not only as a medium of finance but also as a medium that affects certain economic decisions. Like deterring the consumption of a certain good through high taxes on the good, tax exemptions may be applied to encourage investments in certain fields (Pnar, 2006, p. 36). In the post-World War II period, the support of private enterprise through tax policies became a crucial and common characteristic in the market economy of developed countries. On the other hand, this kind of tax policy as carried out through taxes on the return on capital, depreciation, and tax exemptions, did not have a significant weight on economic stability and as an investment incentive in developing countries. In these countries, tax policies were not utilised as much as other policy tools such as foreign exchange rate, interest rate and trade policies for investment incentives. Instead, these countries more frequently used tactics such as affecting the capital cost of the private sector through direct interference in financial markets and foreign exchange rates, regulating investment decisions, and project selection (Pnar, 2006, p. 208). These direct supports caused misdistribution of the sources, ineffective

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investments and inefficiently operating firms.

Tax Policies and Regional Development The effect of taxes on economic units can be understood through various approaches. The effects of taxes manifest themselves in the economy as production, consumption, and personal income distribution. Accordingly, taxes affect production through the roles they play on production decisions, investment volume, production costs, and level of employment, technical foundation, financial structure and locations of firms (Türk, 2008, p. 225). In terms of production, the effects of taxes may be divided into two: income and substitution effects. The income effect is the tendency of people to have less income due to the tax, and to consume fewer goods and services to work, and produce more in order to compensate for this loss. The substitution effect, on the other hand, is the tendency of people to work less as they find their after-tax income low (Pnar, 2006, pp. 38, 39). Taxes’ effects on consumption are revealed in two ways. If taxes are indirect taxes, they lower the personal incomes of taxpayers. In this case, taxpayers determine their consumption preference according to their aftertax incomes; this in turn lowers the savings of taxpayers having high income, and causes taxpayers having low income to decrease their consumption. Secondly, indirect taxes are levied on goods and services. Increases or decreases in the tax ratios levied on goods and services cause the demand of these goods and services to decrease or increase as the changes in the indirect taxes are reflected in the prices of these goods and services (Türk, 2008, p. 228). In practice, governments have given particular importance to decreasing consumption. In fact, customs duty, consumption tax and excise duty are applied to restrict consumption. Nevertheless, their effects to decrease consumption are not always precise and fair. For controlling consumption through taxes, special discounts in income taxes or a subsistence allowance should be reconsidered in line with the needs; income tax tariffs should be rearranged; the proportion of taxes applied to education, health and life insurance services in total consumption taxes should be regulated; and the proportion of taxes levied on luxury consumption (tobacco, alcoholic beverages, automobile, petrol, video...) should be kept high for these controls to be more efficient. In order to attain this goal, the taxrelated regulations should be made systematically (Türk, 2008, p. 229).

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However, the development policies envisaged for developed countries may differ from those for developing countries due to the structural differences among countries. The main objective of fiscal policy in developing countries is to ensure development through creating a stable environment. In developing countries, the objectives of tax policy are: (i) to regulate resource allocation for developing activities having high social performance, (ii) to promote the private sector with tax concessions and similar fiscal measures, (iii) to control inflationist tendencies in the economy, (iv) to reduce inequalities in the distributions of income and wealth, and (v) to create resources for public sector activities (Siverekli, 2003, p. 100, 101). In these countries, there is no efficient market economy that is sensitive to the measures of economic policy. Market powers do not operate up to the mark. Therefore, the use of scarce economic resources is not rational. These failures and inadequacies in the economy require intervening tax policies. Through tax interventionism, activities that ensure economic development would be promoted and supported, while others that do not ensure economic development would be deterred. This kind of tax policy is called incentive tax policy. The measures of incentive tax policy reduce the cost of investments and increase profitability. The main promotions rooted in incentive tax policies are temporary tax exemptions and allowances, investment discounts, accelerated depreciation, temporary customs duty exemptions and allowances, customs duty installments and diversifications, tax claims, appropriation from one tax to another, and the appropriation of the losses firms face from other years’ profits for certain duration. These means attempt to alter the investment decisions of entrepreneurs, rationalize their behaviors and render their investment plans proper and harmonious. The realisation of all these matters may be possible with an intervening tax policy (Türk, 2008, p. 135- 136). The principal reasons to give weight generally to indirect taxes for adapting the savings of a country are as follows (Edizdo÷an and Çelikkaya, 2012, p. 228-229):  In such countries where taxable income is low, relying on indirect taxes, such as income tax, would decrease the yield of the tax revenue of the Treasury;  As industry has not developed adequately and as agricultural structure prevails in such countries, giving weight to indirect taxes would create obstacles to the taxation of agricultural income, and

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adequate income would not be attained;  Above all, giving weight to indirect taxes would undermine investment enthusiasm and investments would be affected negatively, hence creating a contractionary effect on the economy.

Tax Incentives and Regional Development In general, incentives are political methods used for the orientation of resources to productive fields through strategies determined for the promotion of the level of national wealth. Incentives may be tax incentives, low interest loans or grant aids, as well as methods ensuring energy discounts, land allocation and financing facility (Yayar and Demir, 2012, p. 121). Accordingly, basic fiscal policy means, such as tax and public expenditures, are too often policy instruments consulted for incentive applications. Tax incentives and measures express the diversification of tax applications according to the subject or issue that the incentives and measures address. These incentives and measures are applied for the realisation of economic and social objectives such as economic development, balanced allocation of investments among sectors and regions, promotion of exports, attainment of foreign competitiveness, and formation of various social affects (Tanröven, 1989, p. 332). The types of tax incentives may be sorted as (i) tax exemptions, (ii) depreciation discounts, (iii) tax credits, (iv) mutual funds, (v) tax ratio reductions, (vi) tax payment eases and (vii) other measures (Tanröven, 1989, p. 335-336). Together with the fact that tax incentives may have effects on investments depending on the type of incentive applied and the quality of the application, the economic characteristics of the country and the competitive environment in which the sector belongs also have effects on the increase of the sectoral competitive power. In order for a tax incentive to be effective, it is necessary to check whether the incentives given to certain projects diminish the effective tax incidence of investors or are not compared to the tax incidence in case of the lack of any tax incentive (Özker and Biniú, 2010, p. 498). However, there are various discussions on the efficiency of tax incentives. While some of these discussions support that tax incentives are efficient, others claim that they are not. The Table below refers to some of them.

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Table 6-2: Discussion on the efficiency of tax incentives POSITIVE

NEGATIVE

In their studies on the relationship between tax incentives and investment decision and employment, Papke (1991), and Gullec and Potterie (2003) show that incentives have effects on employment growth.

In their study on the relationship between tax incentives and regional economic growth and employment increases, LynchFishgold- Blackwood (1996) reveal that incentives have no effects.

In their study on the effects of tax incentives on manufacturing investments, De Bartolome-Spiegel (1997) determines that incentives have insignificant effects.

In their study on the relationship between tax incentives and employment, Bondonio-Engberg (1999) determines that incentives have no effects.

In their study on the relationship between tax incentives, investment decisions and regional growth, Byrness-Marvel-Sridhar (1999) find that incentives have insignificant effects.

In their study on the relationship between tax incentives and regional economic growth, Goss and Philipps (1999) reveal that incentives have no effects.

In his study on the relationship between tax incentives, and employment increase, investment decisions and productivity increase, Chhatre (2000) shows that incentives have insignificant effects.

In his study on the relationship between tax incentives, investment decisions and employment, Bernstein (2002) shows that incentives have no effects.

In their studies on the relationship between tax incentives and investment decisions, employment increase and regional economic growth, Peter-Fishers (2002) and Russo (2004) reveal that incentives have insignificant effects.

In their studies on the relationship between tax incentives and investment decisions, Plummer (2002), Ward (2002) and Mai (2002) show that incentives have no effects.

Source: Tezcan and Çukurçayr, 2011, p. 130

Despite these discussions, incentives are applied in many countries in order to attract investments. The principal advantages of tax incentives could be sorted as follows: (Edizdo÷an and Çelikkaya, 2012, p. 142): (i)

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incentives are used as the means that counteract the effects of laws. They play a controller role in the removal of irregularities such as foreign exchange controls and license limitation; (ii) irregularities in the labour markets may be corrected; (iii) as capital markets generally do not suit small enterprises, incentives benefiting these enterprises may remove these irregularities; (iv) temporary incentives may help small industries to be founded; (v) promoting investments may create some external benefits (such as innovation and education) for the economy and investors; and (vi) promoting investments, especially for new investors, may be accepted as the indicator of the openness of the country. Despite these possible aforementioned advantages, incentives are criticized for the following reasons: (i) they complicate tax management; (ii) they corrode tax assessment and cause higher tax ratios; (iii) incentive plans are generally a result of the movement of a group instead of the analysis of the economy as a whole; thus, some sectors are supported more than others; (iv) compared to a general allowance in corporate tax, they are less successful for attracting foreign investors; (v) they result in an unequal tax burden among taxpayers; (vi) they generally have little effect on new investments; and (vii) they create higher irregularity in the economy (Edizdo÷an and Çelikkaya, 2012, p. 143). Accordingly, the incentive priority of certain regions and sectors should depend on certain calculations and plans but not on the political power of certain groups and persons (Yayar and Demir, 2012, p. 122).

An Examination of an Incentive System: Turkey In the context of globalisation, economic, social and technological changes have appeared around the world. These evolutions have forced governments to make changes in their implementations. One major change is realised in taxation.

The History of Tax Incentives in Turkey Incentives have been used for many years in Turkey to increase investment, employment and welfare levels, and to eliminate regional differentials. In the first years of the Republic in I. Economy Congress, the necessity for incentive regulations for the private sector was expressed. As a step to achieve this goal, the Industrial Encouragement Law was enacted in 1927. However, this regulation, which gave weight to import, substituting incentives, had been in force for 15 years, and because of

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unexpected results, it was repealed in 1942. Then in 1954 the “Foreign Investment Incentive Act,” which aimed to attract private foreign capital into the country, entered into force. In addition to these regulations, Turkey actually first realised the importance of incentives through development plans. The first development plan, covering the years 1963 to 1967, aimed at regional development targets and brought into prominence incentives to eliminate the differences of inter-regions. The basis of the present incentive system is Law no. 933, which was adopted in 1967. By 1968, a “Priority Development Areas” application for lagging regions was launched to resolve imbalances between regions. Through the liberal economic decisions of January 24, 1980, investment incentives increasingly were applied as a policy tool. In this context, a “Resource Utilization Support Fund” was placed as a grant in 1985. With this grant, a large increase was observed in investment incentives (Karabçak, 2013, p. 266). By the 1990s, with Turkey being a member of the Customs Union and World Trade Organisation in 1996, the structure of the incentive system was modified. According to these regulations, an arrangement had been adopted which took into account regional disparities rather than a sectoral incentive scheme (Karabçak, 2013, p. 266). The regulations made in the incentive system in the 2000s were striking. During the 2000s, Turkey implemented some incentive programs, in 2004, 2006 and in 2009, and announced the final one in April, 2012. In these regulations, the effect of an adjustment process to the European Union was obvious. This effect was shown clearly in the Decree of the Council of Ministers dated September 9, 2002, and published in the Official Gazette of the Turkish Republic No. 4720. With the given decree “regional statistics gathering and developing, making the socio-economic analysis of the regions, in order to determine the framework of regional policies and to make comparisons with the EUROPEAN UNION regional statistics, creation of statistical territorial units” was arranged. In this direction, Turkey created three levels of Nomenclature of Territorial Units for Statistics (NUTZ). In NUTZ I, regions were separated into 12 groups; in NUTZ II, regions were separated into 26 groups; and in NUTZ III, 81 provinces were separated into various groups (Hasano÷lu and Aliyev, 2006, p. 86). The purpose of the incentive systems that were introduced in 2004 and 2006 was to implement tax and insurance premium subsidies, to provide energy support and to increase the investment and employment opportunities in the particular provinces by giving free land (Savrul and

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Do÷ru, 2013, p. 4). The incentive system numbered 2009/15199 took effect on July 16, 2009. Thus, the practice of Priority Development Areas which had applied for 41 years was terminated. With the objective of eliminating regional imbalances, the provinces were divided into four different groups according to their socio-economic development levels by using the 2001based data of the State Planning Organisation (Acar and Ça÷lar, 2012: 2). In the first region, 14 provinces; in the second region, 10 provinces, in the third region, 27 provinces; in the fourth region, 30 provinces were regulated. The instruments among the regions were regulated differently. The goals of the incentive system that was announced in 2009 were described as, “in compliance with the development plans and the objectives stipulated in the annual programs, as well as the international agreements, to direct the savings toward the investments with high added value, to increase production and employment, to ensure the sustainability of the investment tendency and sustainable development, to encourage large-scale investments with high content of technology, and research and development, to increase direct foreign investments, to overcome regional development differences, and to support research and development activities regarding the conservation of the environment.” The latest incentive system, which was announced as a new investment incentive scheme, was declared in 2012. The objective was expressed as, “to support clustering and high-technology investments for improving global competitiveness, to reduce the current account deficit, to increase the added value of production, to increase the efficiency of support instruments, to ensure development in the least-developed regions, to overcome regional disparities” (Decree Number 2012/3305, article 1). As a result, Turkish tax incentives have been used in order to promote several socio-economic goals from the 1980s to the present. When the nature of the incentive systems in the 2000s is examined, it is seen that each incentive scheme appeared more widely. All of the revisions comprise sectoral separations. In 2004 and 2006 there were three support instruments, and then in 2009 the number increased to five and became eight in 2012.

The Types of Tax Incentives Many developing countries, including Turkey, have several incentive implementations in order to encourage investment. One of the devices is tax incentives, which are used to encourage investment. The holiday tax

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incentive is a common incentive instrument within the tax incentives. The Turkish incentive system combines both tax incentives and non-tax incentives. Tax incentives were introduced in Turkey in the late 1980s. The tax incentive program has been administered by the Turkish Revenue Agency under the direction of the Minister of Finance. Tax incentives in Turkey from past to present can be categorized in the following way (Revenue Administration, 2014a, 2014b): a) Investment Deduction: Corporate taxpayers and income taxpayers who have business and agricultural earnings benefit from this tax incentive instrument. In this incentive, under certain conditions, a particular amount of expenditures can be reduced in the calculation of taxable income. In this way, the investment cost is decreased by affecting the profitability of the investment. During recent years, without any regional or sectoral discrimination, all investments have started to benefit from the investment deduction. Effective January 1, 2006, under the law numbered 5479; the investment deduction has been abolished. This law was accompanied by temporary article 69i, which set up transition period applications. b) Deduction of Research and Development Expenditures: In the first regulation which had been valid since July 31, 2004, 40% of research and development expenditures could be deducted from the income declared on annual tax returns. The expenditures must be related to new technology and knowledge acquisition. Regulations made by the law on the Support of Research and Development Activities no: 5746, in effect since April 1, 2008, raised tax incentives on research and development activities, and procured new additional incentives. The most important change was made in 2008 in which 100% of research and development expenditures could be deducted while determining the declared income. c) The Other Incentives about Research and Development: Personnel employed in research and development enterprises (R&D) are exempted from stamp duty, wages earned by the R&D shall be cancelled from income tax (income tax stoppage) at a rate of 80% to 90% (income tax stoppage) and given insurance premium support. d) Gain Exclusion on Education and Instruction Businesses: Business income taxpayers can take advantage of this exclusion within the scope of the law numbered 625. The exclusion applies to the gains obtained from pre-school, primary, secondary and high school

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e)

f)

g)

h)

i)

education. With the exclusion, gains earned from operating private schools are excluded from income tax for five taxation periods. At the same time, private schools that meet the requirement not to pass over 10% of capacities during relevant periods are also excluded from value added tax (VAT). Incentive of Value Added Tax in Vehicles, Oil Searching and Incentive Certificated Investments: Taxpayers who have specific certificatesii, whose activities concern gold, silver and platinum within the scope of the Oil Exploration Law ruling, are excluded from value added tax. Tax Incentives in Industrial Zones: In this incentive, which was regulated in the Incentive of Investments and Employment Law numbered 5084, doing business in industrial zones has some advantages. Doing business in these regions is supported by income tax withholding, support in employer shares of insurance premiums, free investment space and energy support. Tax Incentives in Technology Development Zones: The earnings of entrepreneurs doing business in technology development zones are excluded from income or corporate tax until December 31, 2023iii. The businesses operating in these zones comprise of delivery and services, system management, data management, business applications, sectoral, and internet, mobile and military command control application software. These businesses are also excluded from VAT. Tax Incentives Applied in Free Zones: Taxpayers who have license to function in free zones, which were founded due to the law numbered 3218, are excluded from income tax of personnel wages and every kind of tax and fees until December 31, 2008. In addition, goods and services in free zones are excluded from VAT. This incentive is still in force. Tax Incentives Applied in Emergency Zone and Priority Development Areas: Investments in emergency zones and priority development areas, to meet the requirements of these places, can benefit from income and corporation tax exclusions, tax deductions and free investment land by the law numbered 4325. On the other hand, without making any regional discrimination, in all the regions, priority investments benefit from incentive instruments at the same rates and terms. In addition to this, priority investments have more advantages for investments made in organized industrial zones in Region 5 and those made in or out of organized industrial zones in Region 6.

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j) Tax Incentive Applied in Organized Industrial Zones: Investments done in organized industrial zones have some advantages. In the context of the Investment and Employment Law numbered 5084, some incentives are presented to income and corporation taxpayers. These incentives consist of an income tax withholding incentive, employer contribution incentive, free investment land allocation and energy support. Besides these, investments are exempt from all types of tax and fees within the Organized Industrial Zones Law. Buildings in organized industrial regions take advantage of real estate tax exclusions for 5 years following completion. k) Tax and Fees Exclusion in Providing Credits: This tax incentive comprises an exemption from stamp duty. In this context, papers which will be exempt from stamp duty have to be used by banks, credit enterprises abroad and international associations in order to be constructed for acquisition or payback of credit. l) Tax Incentives for Increasing Investment and Employment: Law numbered 5084, which aims at increasing investment and employment, contains an income tax withholding incentive that will be applied following the completion of the investment in provinces until December 31, 2007. Within the scope of the law, which still exists, some advantages are applied such as: no income tax withholding from the wages of new personnel, payment of employer contributions by the treasury, energy support and free investment place allocation. m) Tax Incentives for Cultural Investments and Enterprises: Within the law numbered 5225, cultural investments and enterprises found an opportunity in the phase of investment and for a length of time to use incentive tools such as income tax withholding deductions, allocation of immovable property, abatement in employer contributions, water cost discounts and energy support. Besides these incentives, they can also employ foreign personnel or artists, and have the ability to operate on weekends or official holidays. n) Reduced Corporate Tax: Reduced corporate tax is in accordance with the targets set in the annual program and development plans, aimed to direct savings to high value-added investments, to increase production and employment, to encourage large-scale investments which will increase international competitiveness, to increase foreign direct investments, to remove regional differences in terms of development and to support research and development activities. The investments which can benefit from this incentive have to take incentive certificates from the Ministry of Economy.

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After that, the Ministry will apply a reduced tax rate to their earnings. From 2012, regional and large-scale investments which have incentive certificates have begun to use the reduced corporate tax. Reduced tax application will be continued until the deducted corporate tax or income tax amount reaches the investment contribution amount. According to the law numbered 5838, temporary article 4, investments which are operated in certain provinces as determined by the Council of Ministers and which are functioning exclusively in textile, garment and ready-made, leather and leather products are exempted from the corporate tax rate of 75%. Investors had to transfer their investments to certain provinces by December 31, 2010 and had to provide an employment minimum of 50 persons. This incentive applies from the beginning of the transfer date for five years. At the same time, income taxpayers can also benefit from this incentive. o) Tax Incentives Applied in the Context of Turkish International Ship Registry Law and law number 491: Ships or yachts which are registered Turkish international ships take advantage of this incentive. In the scope of the incentive, earnings from operating and transferring registered ships and yachts are exempt from income, corporate taxes and funds. Also, wages paid to employees working in the registered ships and yachts are exempt from income tax and funds.

New Incentive System The Turkish Parliament adopted a law to stimulate the economic development of the country by providing tax relief for investors who invest in the most backward provinces of the country. The new incentive system became effective by the State Incentives in Investments Decision no: 2012/3305, enacted on June 19, 2012, and the Notification on State Aid for Investments and Application of the Decree no: 2012/1, issued on June 20, 2012. The new incentive system came into effect as of January 1, 2012. These instruments were announced as a step of reform action, and they would trigger something positive in the following years. The primary objectives of the incentive regime are reducing the current account deficit, encouraging investors to direct their investments into the backward regions of the country, and shrinking inter-regional disparities. The characteristics of the new incentive schemes can be categorized as:

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 Equal access for both local and foreign investors.  New instruments, namely strategic investment schemes, are taken into the incentive scheme.

 Provinces are divided into six groups in terms of the priority of    





incentives. In this division, the provinces’ social-economic developments are taken into account. New incentive tools, such as income tax withholding, social security premium support and VAT refunds are introduced into the existing incentive system. In the new incentive scheme some investments are classified as prioritised for the first time in incentive systems. Investors will benefit from government support not only during the operation stage but also in the investment stage. Investments made in Organized Industrial Zones (OIZs) receive special treatment from the incentive program. Investments made in OIZs will benefit from the rates, one rank higher than the one where the OIZ province is located (Acar and Ça÷lar, 2012, p. 4). Grants have more advantageous support for investments to be initiated by the end of 2013. Spending at least 10% of the investment amount will suffice for the investment to be considered as started. Investors who want to utilise incentives have to take an Investment Incentive Certificate (IIC). The application for an Investment Incentive Certificate is made to the General Directorate of Incentive Application and Foreign Capital under the Ministry of Economy.

The new incentive scheme is formed as the following types: general, regional, large-scale and strategic. They all have certain support incentive instruments.

General Investment Incentive Implementations Investments which do not take part in regional, large-scale and strategic investments are stated as general incentive implementations (Decree Number 2012/3305, article 4/2). General incentives’ most remarkable regulation is that all projects meeting both the specific capacity requirement and the minimum fixed investment amount are supported within the framework of the General Investment Incentives Scheme. There

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is no regional or sectoral discrimination to benefit from incentive elements; only some investment subjects are excluded from the scheme (General Directorate of Revenue Policies, 2012, p. 3). The minimum fixed investment amount is 1 million TL in Region 1 and 2, and 500, 000 TL in Region 3, 4, 5 and 6. The fundamental rule is to get an Investment Incentive Certificate in order to take advantage of investment incentives. However, in the case of investments which are in the scope of general investment and fixed investment amounts which do not exceed 10 million TL, there is an exception for this obligation. For the manufacturing industry investments, investors, depending on their preference, can get a certificate from the local Chamber of Commerce where the investment will be.

Regional Investment Incentive Implementations Regional incentive implementations are regulated in the law numbered 2012/3305. It is stated that, “sectors on basis of provinces may benefit from the incentive elements provided that they comply with the criteria of the relevant region where the province is located” at Article 4 (Decree Number 2012/3305, article 4/3). As stated, the sectors to be supported will vary among the inter-regions. Regions are divided into six classes, based upon their socio-economic development. The minimum fixed investment amount is defined separately for each sector and region, with the lowest amount being 1 million TL in Region 1 and 2, and 500,000 TL in the remaining regions.

Large Scale Investment Incentive Implementations The investments fulfilling the minimum amounts may benefit from the support (Decree Number 2012/3305, article 4/4). In this incentive implementation, the investment’s regional location is taken into consideration. On the other hand, as well as depending on the sectors, investments have to be above 50 million TL. Investments in seaports and seaport services, primary motor land vehicles and chemical substances and products manufacturing will require a minimum investment of 200 million TL, and investments in refined petroleum products manufacturing require a minimum investment of 1 billion TL to be considered as a large-scale investment.

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Strategic Investment Incentive Implementations The strategic investment incentive has a different significance in the incentive system. It is constituted as a new category of incentive implementation within Decree Number 2012/3305. This incentive is aimed at particular investments which have the potential to decrease account deficits and to support high tech and high value added investments in order to increase the competition capacity in the international area. To be a strategic investment, an investment has to contain following required criteria (Decree Number 2012/3305, article 8):

 The minimum fixed investment amount is above 50 million TL.  The total domestic production capacity for the product subject to the investment is less than the importation.

 Based on the principles set by the Ministry, the added value to be provided by the investment contained in the certificate is a minimum of 40%.  The total import amount of the subject product to be invested in is above 50 million USD within the last year. New investment incentive instruments are shown in Table 6-3 as a summary. Table 6-3 demonstrates that not only the type of investment is determinative, but also the degree of socio-economic development is another determinant of investment schemes. Incentive elements show a change between the types of incentive implementations. For example, the general incentive will only be promoted through VAT, customs duty exemptions and, only in Region 6, an income tax withholding allowance will also be available on labour wages. When we look at the structure of new tax incentives, we see that some of the instruments were already available in different ways before. But they could represent a positive and aggressive step for the economy, especially for regional economic development.

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Table 6-3: Framework of New Investment Instruments Support Instruments

General Investment Incentive Scheme

Regional Investment Incentive Scheme

Largescaled Investment Scheme

Strategic Investment Scheme

VAT Exemption













Customs Duty Exemption













Tax Reduction










Social Security Premium Support (Employer’s share)



















Social Security Premium Support (Employee’s Share)*










Interest Support**




Land Allocation




Income Tax Withholding Support*




VAT Refund***









*Provided that the investment is made in Region 6. **Provided that the investment is made in Regions 3, 4, 5 or 6 within the frame of the Regional Investment Incentive Scheme. ***Provided that the investment is made within the frame of strategic investments with a minimum fixed investment amount of over 500 million TL. Source: Republic of Turkey Ministry of Economy, 2012:1

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Practice of Regional Tax Incentives in Turkey One of Turkey’s main economic problems is an inter-regional imbalance. These imbalances caused less developed regions not to integrate with other regions. Thus, the imbalances between the regions became deeper. Turkey intends to eliminate regional instability, like many other countries. In accordance with this, legislative and legal arrangements have been made for ensuring incentives to investors. Tax incentives can be defined as the fundamental driver of regional economic development. Regional Incentives in Turkey Regulations related to regional incentives in Turkey have been covered by legislation for many years. The Turkish government has supported regional economic development through development plans that provide significant instruments to eliminate regional instabilities. The strategies and policies for evaluating the regions’ potential are regulated under the topic of regional development and regional competitiveness in the last development plan (Tenth Development Plan), which covers the years 2014-2018. Parallel to this, the Regional Development High Council and Regional Development Committee have been established for providing applications’ unity (Ministry of Development, 2013, p. 136). In addition to this, various direct and indirect support elements have been used to remove imbalances between the regions. In order to achieve regional economic development, countries manage numerous encouragements such as the exemption of tax, duty and charge, exemption of customs duty, VAT support, incentive credits, allocation of lands and subsidies (Yayar and Demir, 2012, p. 122). When we analyse the past practice of regional incentives, it is seen that provinces have been subject to discrimination in terms of the levels of socio-economic development. According to the “Provinces and Regions Socio-Economic Development Ranking” research report of the State Planning Organisation, under the new name of the Republic of Turkey Ministry of Development, in 2003, each region is divided into four groups within itself, and these groups are classified as twenty sub-groups depending on their socio-economic development level in total (Yayar and Demir, 2012, p. 125). This research report was revised in 2011 by the Republic of Ministry of Development, which arranged the same groups of provinces under the same regional incentive system.

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Laws numbered 5084 in 2004 (including 36 provinces), and 5350 in 2005 (including 49 provinces), on Investment and Employment Incentive made changes in the incentive system. In the incentive package which was enacted in 2009, sector-based regional incentives were revised. Regions were grouped into four categories. Before 2009, the application of regional incentives did not take sectoral priorities into consideration. By 2009, the application of regional incentives introduced sectoral priorities. Faults that appeared during the three-year application of the incentive system were taken into consideration and the latest investment system, dated 2012, and regulated new incentive tools (Acar and Ça÷lar, 2012, p. 2).

Incentive Instruments in the Scope of Regional Incentive Scheme With the new regional incentives, instead of generating geographical regions, each province has been designated as a part of one of the six socioeconomic regions. The incentives will be larger ranging from the first region to the sixth region of Turkey. Investors have taken the most advantage in the sixth region, which has had the least socio-economic development (Gümüú, 2013, p. 90). The investors who will benefit from regional incentives vary from one region to another. The minimum fixed amount of investment is determined separately for each sector and each region; the lowest amount is 1 million TL in Regions 1 and 2, and 500,000 TL in the remaining regions. For the regional investment incentive scheme, sectors stated in Attachment No: 2B with related provinces can benefit from incentives, and this provided that they meet the conditions determined for the provinces in the related regions, as explained in Attachment No: 2A. The terms and rates of support provided within the Regional Investment Incentive Scheme are shown in the following Table. Table 6-4 presents the regional investment incentive scheme instruments. It is seen that the regional investment scheme instruments are mainly composed of tax incentives. There is an advantage to investing in Organized Industrial Zones. We see this advantage both in the rate of contribution to investment and support period. These incentives can be classified under seven groups:

Local Loans

Land Allocation Interest Payment Support

Source: General Directorate of Revenue Policies, 2012

-

-

20

-

15

Within OIZ*

15

+ -

10

Out of OIZ*

Upper Limit for Support (%)

5

3

25

2 + + 20

+ -

3

Within OIZ*

Within OIZ* 2

20

Out of OIZ*

Out of OIZ*

1 + + 15

Foreign Exchange/ FX Denomination Loans Social Security Premium Support (Employee’s Share) Income Tax Withholding Allowance * OIZ: Organized Industrial Zones

Support Period (year)

Rate of contribution to investment (%)

Social Security Premium Support (Employer’s Share)

VAT exemption Customs Duty Exemption Tax Reduction

Incentive Instruments

Table 6-4: Regional Investment Incentives Scheme Instruments

-

1

+ 3

25

20

6

5

30

3 + + 25

-

1

+ 4

35

25

7

6

40

4 + + 30

The Effects of Tax Incentives on Regional Economic Development

-

2

+ 5

No limit

35

10

7

50

Region 5 + + 40

10 years 10 years

2 points

+ 7 points

No limit

No limit

12

10

55

6 + + 50

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1.Customs Duty Exemption According to Turkish Customs Legislation, customs duty is exempted in cases of the importation of machinery and equipment, provided that all machinery and equipment should be within the scope of the Investment Incentive Certificate. All investments can benefit from the exemption from customs duty, except for the investment items that are not to be encouraged and the investments which do not meet the conditions. In accordance with the Import Regime Decree certain imported items are exempted from customs duty. As an example of these investment goods in the scope of incentive certificates, machinery and equipment imports can be shown (Decree Number 2012/3305, article 9). 2. VAT Exemption Except for investments that are not to be encouraged and investments which do not meet the conditions, all investments above the lowest investment amount (500 million TL), will benefit from the VAT exemption. The VAT exemption is applied to all investments on the condition that they at least provide the minimum investment amount. In the scope of the VAT exemption, investors who have an Investment Incentive Certificate (IIC) do not pay VAT for imported and domestically provided machinery and equipment (Law on VAT numbered 3065, article 13). However, in case of any failure in the investment program, all VAT amounts exempted shall be collected with late payment fees and penalties by the Tax Administration. On the other hand, transfer transactions of the incentive certificate or machinery, and equipment contained within the scope of incentive certificate and the partial delivery of the goods stated as sets, units, kits and etc. in the machinery and equipment lists (Decree Number 2012/3305, article 10) are exempted from VAT. 3. Tax Reduction Another instrument relates to the regional incentives to benefit from a tax reduction. The Decree of the Council of Ministers numbered 2012/3305 states that, “the corporate tax or income tax pursuant to article 32/A of Law No. 5520 shall be applied with reduction at the certain rates until the estimated investment contribution amount is attained” (Decree Number 2012/3305, article 15). As is understood from the article, tax reductions can be applied until the cumulative reduction reaches a certain percentage of the investment. While calculating the reduced corporate income tax rate, the rate of contribution to investment and rate of tax reduction need to be taken into consideration. Both rates are ordered in Decree Number 2012/3305. This incentive is applicable not only for

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Corporate Income Tax but also for investors in the scope of Individual Income Tax, whose income consists of business profits (KPMG, 2012, p. 7). On the other hand, in order to encourage investors, regulations have been introduced in terms of duration. We show the application of this incentive below in Table 6-5. Table 6-5: Tax reduction in regional investment incentive scheme Investments Started Before

Investments Started After

December 31, 2013

January 1, 2014

Investment Contribution Rate (%)

Corporate tax or income tax reduction rate (%)

Investment Contribution Rate (%)

1

15

50

10

30

2

20

55

15

40

3

25

60

20

50

4

30

70

25

60

5

40

80

30

70

6

50

90

35

90

Zones

Corporate income reduction (%)

or tax rate

Source: Decree Number 2012/3305, article 15/1-2

As is seen in Table 6-5, investments started before December 31, 2013 in Region 1, the contribution to investment rate for investments started before December 31, 2013 was 15%, while this rate is 10% for investments started after January 1, 2014. The contribution to investment rate for investments after January 1, 2014, was respectively 10%, 15%, 20%, 25%, 30% and 35%. For instance, for investments located in Region 1, the tax reduction rate of 50% would be applied until it reached the investment amount’s contribution rate of 15%. For investments starting after January 1, 2014, contribution to investment rate is 10%. Investors who began investment before December 31, 2013, could benefit from a maximal 90% tax rate reduction and up to 50% contribution to investment rate. The reduced corporate tax rate applies not only to earnings derived from certified investments but also to earnings derived from all activities in the period of investment until reaching a certain percentage of the

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investment contribution limit, for investments in the 2nd, 3rd, 4th, 5th and 6th regions. Before the new investment incentive system, tax reduction incentives applied only to income generated from the relevant investment within the construction phase. With the new incentive system, the opportunity to apply for a corporate tax reduction during both the investment and operation periods is provided with different rates (Gümüú, 2013, p. 112). The implementation continues until the investment contribution limit is reached. It is shown in the following Table 6-6. Table 6-6: Application of regional investment incentive scheme Rate of Contribution to Investment (%)

Tax Reduction Rate (%)

1

15

50

10

0

100

2

20

55

9

10

90

3

25

60

8

20

80

4

30

70

6

30

70

5

40

80

4

50

50

6

50

90

2

80

20

Zones

Reduced Tax Rate (%)

Investment contribution rate to be applied before and after investment is completed Investment Period

Operating Period

Source: Republic of Turkey Ministry of Economy, 2012

4. Social Security Employer’s Share Premium Support Social security employer’s share premium support is arranged in the Decree of the Council of Minister numbered 2012/3305. In the scope of this incentive it is stated that, “for the additional employment created by the investment, employer’s share of social security premium on portions of labour wages, up to amount of legal minimum wage, will be covered by the Ministry of Economy” (Decree Number 2012/3305, article 12). The support is calculated by the minimum wage per worker. The investments which make use of this support must have an Incentive Investment Certificate (IIC). The given support applies to employment created by completely new investments. The employment level must be above the current employment in order to take advantage of

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social security premium support. This incentive is carried out by Turkish Social Security Legislation. The correctness of information given by the investors about this support is controlled by the Social Security Institute (Gümüú, 2013, p. 110). By Decree Number 2012/3802, which made alterations to Decree Number 2012/3305, current arrangements related to Regions 1, 2, 3, 4 and 5 remain stable, but support related to Region 6 has been amended. For investments realised in Region 6, there is no limit for application of the social security premium employer’s share support rate to the fixed investment amount (Decree Number 2012/3802, article 1). The implementation period and maximum support rate of the social security employer's share premium support are shown in Table 6-7 below: Table 6-7: Application of social security employer’s share premium support

Zones

Investments Started Before December 31, 2013

Investments Started After January 1, 2014

Social Security Premium Employer Share Support Rate to the Fixed Investment Amount (%)

1

2

-

10

2

3

-

15

3

5

3

20

4

6

5

25

5

7

6

35

6

10

7

No limit

Source: Decree Number 2012/3305, article 12/2; Decree Number 2012/3802, article 1

As is seen in Table 6-7, this support can be applied for a maximum of 10 years, and the regulation does not limit the fixed investment amount. The investments in Region 6 can benefit from the support for a period of 10 years with the condition of starting the investment before December 31, 2013. The investments started after January 1, 2014 benefit from this support for a period of 7 years and, as an important point, Regions 1 and 2 cannot take advantage of this support. 5. Land Allocation A land allocation incentive was adopted into the incentive system with Decree Number 2012/3305. Any investment that cannot benefit from the

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reduced corporate tax reduction cannot get benefit from land allocation support (Decree Number 2012/3305, article 16). Investments which can provide land allocation have to obtain Investment Incentive Certificates. The rules and principles concerning land allocation are determined by the Ministry of Finance (Republic of Turkey Ministry of Economy, 2012). While determining the rules and principles for this support, the Ministry takes into account for the Article of the Law numbered 4706, article 3. According to the regulation, the total amount of investments to be realised on real property cannot exceed the amount which is appreciated by the administration through the current value of the property. This investment amount cannot be less than the appreciated current value for investments in agriculture and livestock, less than two times the value for tourism investments, and less than three times the value for other investments. If the investment is planned to be located in Organized Industrial Zones and Industrial Zones, but the location has not been found yet, then for a period of 49 years an easement can be installed. After the land allocation, for the first year investors have to pay 3% of the real property as a real estate tax value, they need to complete the investment within the time provided and, from the beginning of the operating period, have to protect the employment number which is stated in the incentive certificate for five years. Except for agriculture and livestock investments, land will be purchased directly, in order to provide an investment amount of 50,000 USD and additionally, to employ at least 100 people and to realise at least three times the amount of investment which is required to purchase the real property (Gümüú, 2013, p. 107). 6. Interest Support Interest support is a financial support instrument, provided for the loans with a term of at least one year as obtained within the frame of the Investment Incentive Certificate. The measure stipulates that a certain portion of the interest share regarding the loan equivalent of, at most, 70% of the fixed investment amount, as registered in the certificate will be overlaid by the Ministry of Economy (General Directorate of Revenue Policies 2012, p. 9). The support measures are limited in this incentive instrument. It can only be applied to loans related to investments made under the regional incentive and strategic investment schemes, R&D and environmental investments. Except for strategic investments, investments can only get loans from one brokerage firm. If an investor gets loans from more than

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one credit score, the incentive will be applied to only one of the loans. However, it is possible to get more than one credit from a brokerage firm (Republic of Turkey Ministry of Economy, 2012). On the other hand, the rates of interest support depend on inter-investment schemes and interregions. According to the Decree, the interest support for the regional investments is as follows: Table 6-8: Application of interest support Support Rate Zones

Maximum Support Amount(Thousand TL)

Local Loans (Points)

Foreign Exchange/ FX Denominated Loans (Points)

1

-

-

-

2

-

-

-

3

3

1

500

4

4

1

600

5

5

2

700

6

7

2

900

Source: Republic of Turkey Ministry of Economy, 2012

As shown in Table 6-8, regions 1 and 2 cannot benefit from the interest support. The other regions use this support in the form of increasing rates. For instance, in Region 3, interest support will be 3 points for the Turkish Lira denominated loans, while in Region 6; interest support will be 7 points for the Turkish lira denominated loans. There are also limits for the interest support as it will not exceed the amount for the regions. Maximum support amounts vary between Regions 3, 4 and 5, and that from 500,000 to 900,000 TL. 7. Income Tax Withholding Allowance Income tax withholding allowance is arranged in Decree Number 2012/3305 in article 14. The article specifies that, the income tax regarding the additional employment generated by the investment within the scope of the Investment Incentive Certificate will not be liable to withholding. The measure is applicable only for investments realised in Region 6. The income tax withholding allowance is limited to a period of 10 years (Decree Number 2012/3305, article 14). The beginning of this

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time is the partial or complete operating period of the business. Viability of the allowance is determined by the legal minimum wage. The amount of allowance must be within the boundaries of this wage. And it is also limited by the employment number that is stated in the Investment Incentive Certificate. Provided that the operation started partially or fully between July 1, 2012 and December 31,2023 it will be considered within the investment incentives for ten years from these dates. For example, if an investment operating date is December 31, 2023, it can use this allowance up to December 31, 2033. It should not be forgotten that if an investment benefits from ejusdem generis provisions in other laws, it cannot take advantage of the income tax withholding allowance (Gümüú, 2013, p. 116117). 8. Social Security Premium Support (Employee’s Share) Social security premium support is stated in Decree Number 2012/3305 as, “for the additional employment created by the investment, employee’s share of social security premium on portions of labour wages corresponding to the amount of legal minimum wage will be covered by the Ministry according to the Decree.” Only investments made in Region 6 and those made under large scale, strategic investment and regional incentive schemes can benefit from this support. The procedure for the support mentioned in the Decree for the employee’s share is applicable for a period of ten years. The premium of the employee’s share is handled by the Ministry budget on behalf of the employer for ten years following the issuance of completion of the visa as proof of the employment number registered in the incentive certificate. Investors have to pay the employee share of the premium which is not covered by the Ministry duly and timely, and have to issue monthly premium and service documents within the legally prescribed period to the Social Security Institution (Decree Number 2012/3305, article 13).

Investments Benefited From Level Upgrade and Specific Priority Investments One of the new incentive system’s main goals is to ensure clustering in investments. In order to perform this goal, extended support elements are constituted. The investments within the regional and large scale investment incentives scheme will get more benefits by getting level upgrades in regional rates and, terms of tax reduction and social security premium support (employer’s share). These support elements can be seen

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below (Decree Number 2012/3305, article 18):  Investments realised in Organized Industrial Zones (OIZ),

 Joint investments to be made by at least five companies operating in the same sector with the purpose of integrating these companies to this joint investment. For investments made in Region 6 within the concept of regional and large scale investment schemes, investors can have an additional two years for the employer’s social security premium support, and an additional five points of reduced tax rate to the investment contribution rate. In the new incentive scheme, if the investment made is in an organized industrial zone located in Region 6, investors can benefit from support for 12 years. If the investment is made outside an OIZ in Region 6, investors can benefit from support for 10 ten years and can benefit from the employer’s social security premium support on the condition that 50% of the investment amount is not exceeded. With the latest regulation, the maximum support limit related to the employer’s social security premium support is hereafter removed for Region 6. In the scope of this arrangement, investments made in Region 6 will benefit from support for ten years (within OIZ for 12 years). This way, the employer’s social security premium support for workers will be implemented for 12 years in Region 6 (out of OIZ for 10 years) regardless of the investment amount (Akdeve and Karagöl, 2013, p. 121). According to the new investment incentive system, some investmentsiv are regulated under the specific priority areas. The key advantage of this regulation is that investments in the scope of specific priority can benefit from the support instruments which are applicable for Region 5. It is not important to make investments in Regions 1, 2, 3 and 4. When specific priority investment is made in Region 6, its own regional incentive supports will apply.

Tax Incentives’ Effectiveness on Regional Development in Turkey Effectiveness is an accession degree of determined goals. The effectiveness of tax incentives is defined as the detection of how many pre-determined goals are achieved with the given incentives. The term of tax incentives’ effectiveness can be defined as, “the extent to which the investment tax incentive stimulates additional productive investment” (Bolnick, 2004, p. 29). With the tax incentive, it is aimed to shift the sources to more effective regions and sectors, and to use scarce resources

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in more productive areas. Thus, the expected effectiveness of tax incentives can be provided. To achieve a regional development goal, the important point is to determine the resources which will direct regions and sectors properly. Despite several reasons which have an impact on the effectiveness of tax incentives, they can also be changed according to the sector, the type of investment and the cost of the project (Duran, 2002, p. 26). Although it is not possible to precisely measure the effectiveness of tax incentives, various indicators can be used for such a determination. The main indicators for measuring the effectiveness are employment growth, the increase in the income level of the regions and the improvement in the income distribution of the regions. From this point of view, tax incentives given to achieve regional economic development may be a useful tool for stimulating productive investment. On the other hand, while creating tax incentive systems, the government must be attentive; otherwise, the incentive system may cause misallocation and weaken productivity. In Turkey, incentives which have been used in order to eliminate regional disparities and to ensure regional economic development since the beginning of 1963 have been in line with development plans. Although tax incentives have been accordingly put into practice in Turkey for many years in order to eliminate regional disparities, when we look at the results of their application, we see that it is not as successful as expected. From the beginning of the 2000s, relevant arrangements have been made to gain effectiveness in incentive systems. Before the regulation made in the incentive system in 2009, 80% of the incentives provided to investors were given to investors located in the Marmara region. This result can be explained as the distance from the target of ensuring regional development. Table 6-9 demonstrates the results of the 2009 arrangement over the years 2009-2011. Table 6-9: Investment Incentive Statistics between 2009 and 2011 Year

Regional Incentives

Large Scale Incentives

General Incentives

NIC

FIA

Empl.

NIC

FIA

Empl.

NIC

FIA

Empl.

2009

475

5,427

32,154

16

4,815

4,554

1,811

16,866

48,668

2010

1,890

22,953

89,685

21

20,924

6,683

2,192

18,591

52,653

2011

1,517

13,617

61,352

7

5,564

2,097

2,845

34,389

61,532

*NIC: Number of Incentive Certificates, FIA: Fixed Investment Amount (Million TL), Emp.: Employment

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119

Source: Republic of Turkey, Ministry of Economy, 2014

When we analyse the results of investment incentive statistics which were carried into effect with the 2009 arrangement, the numbers of incentive certificates, fixed investment amounts and employment have increased during the period of 2009-2011. For instance, between 2009 and 2011, in the context of regional incentives, the number of incentive certificates increased from 475 to 1,517, fixed investment amount increased from 5,427 to 13,617 and employment increased from 32,154 to 61,352. If we analyse statistics from the point of percentage change, it is seen that the period from 2009 to 2011 shows an increase in number of incentive certificates by 2.19%, in fixed investment amount by 1.51% and in employment by 0.91%. Table 6-10 also presents the distribution of investment incentives within the total incentive instruments. It indicates that in terms of the fixed investment amount in 2009, the regional incentive share is 20% in regional incentive, 18% in large scale incentive and 62% in general incentive. However, with the 2009 change which aimed to emphasise regional incentives, general incentive for the year 2009 came to the forefront. In Table 6-10, in the scope of regional incentives, the number of incentive certificate distribution throughout the regions is shown below. Table 6-10: Number of regional incentive certificate distribution in the regions (2009-2011) Year

1.Region

2.Region

3.Region

4.Region

5.Region

6.Region

Total

2009

124

92

106

2010

409

395

322

58

44

51

475

314

244

206

1,890

2011

386

307

279

252

136

154

1,517

Source: Republic of Turkey Ministry of Economy, 2014

Although it was organized as four regions by the Ministry of Economy in the 2009 regulation, this was revised in accordance with the 2012 regulation. For the purpose of ensuring integrity, provinces in the 2009 regulation were revised with the provinces in 2012 and this is a significant setting for doing a healthy analysis. Table 6-10 points to the regional incentive certificate distribution among several regions. In 2009, the incentive certificate distribution in the regions was actualized in this way: 26.11% in Region 1, 19.37% in Region 2, 22.32% in Region 3, 12.21% in Region 4, 9.26% in Region 5, and 10.74% in Region 6. Years 2010 and 2011 resulted in a similar breakdown with this meaning that it was not realised in the expected direction, but was condensed in Regions 1, 2 and 3.

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With the 2012 Decree, investments realised in the scope of regional investments and large scale investments have required at least five years of operating from the date of beginning activities. Based upon the new instruments, Turkey’s regions are separated into regional degrees with investment incentives. Table 6-11 shows the number of incentive certificates, fixed investment amount and employment from January 1, 2001 to January 31, 2014. In Table 6-11, the region-based incentives application results are summarized. The Ministry of Economy certified 4,978 incentive documents in 2013. While the number of certified documents was 2,051 in 2001, it increased steadily until 2005 and reached 3,913. From 2005 to 2007, the number of certified documents started to decrease; in 2007 it was 2,744. In 2008, the number again increased. But in 2009, it decreased again to 2,302. From 2010, the number of Investment Incentive Certificate documents has increased considerably. As per this result, the 2008 economic measures taken against the economic crisis may be considered to be effective. While in 2001 the certified incentive document number was 2,051, this number increased from 2001 to 2013; the incentive certificates percentage changed by 1.43%. The fixed investment amount in Turkey, or ratio of percentage, has changed by 6.58% in the last 13 years and has now reached 93,785. Data shows that incentives have been given to investors who mostly constitute domestic capital. The investment incentives certified in 2013 provisioned the total employment of more than 190,007 people, 0.80% more than in 2001. The results demonstrate that investment incentive has led certifications and fixed investment amounts to increase, although an increase in employment statistics did not occur to the degree as other indicators. The highest percentage change was in the fixed investment amount at 6.58%. A new investment incentive system, which went into effect on January 1, 2012, made regional distinctions for using incentive instruments. The provinces in Region 6, mostly consisting of poorer eastern and southeastern provinces, would receive the highest support. With the new investment incentive system transferring investments from Region 5 to Region 6, support that can be utilised in an investment period increased from 50% to 80%. Eight provinces in Region 1, 13 provinces in Region 2, 12 provinces Region 3, 17 provinces in Region 4, five provinces in Region 5 and 16 provinces and two cities in Region 6 (Bozcaada and Gökçeada) were located (Savrul and Do÷ru, 2013, p. 6). Incentives have positive effects on national, regional and local development. Incentives can serve to attract investment, and increase economic growth and employment.

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Yavan (2011) analysed that the certified number of documents, fixed investment amounts and employment numbers related to incentives by using regression analysis through the data provided from the 81 provinces, and the results indicate that in a province where the amount of investments, which are related to incentives, shows an increase, this will result in the province’s increase in Gross Domestic Product and per capita income (Yavan, 2011, p. 91-93). The new investment incentive scheme increased Turkey’s investment appeal in 2012; foreign direct investment projects registered a year-on-year increase of 10% (Ernst and Young, 2013, p. 12). The results of regional investment incentives from 2009 to 2014 are shown in the following Table 6-12. As shown in Table 6-12, the results point to increases in all of the data. With the Decree in 2009, which introduced sectoral and regional discrimination into the investment incentive system for the first time, we see that the number of incentive certificates, fixed investment amounts and employment have increased over the years. While the number of certified documents was 475 in 2009, it increased to 1,890 in 2010, which means a percentage change of 2.98%. But in 2011, it decreased again to 1,571. By 2012, increases were revealed in each data point. The number of incentive certificates increased by 0.33% from 2011 to 2012 and by 0.41% from 2012 to 2013. Between 2009 and 2013, the change in percentage was 5.19% regarding the number of incentive certificates, 5.71% in fixed investment amount and 3.17% in employment. Data shows that the impact of incentives to encourage foreign capital was limited, although it is seen that foreign capital was increasing steadily by 2012. We also have to analyse the application results of this incentive with regard to inter-regions with this shown in Table 6-13 below. Table 6-13 reports regional investment incentives specific to tax incentives. It demonstrates that they have the potential to reduce regional imbalances. We provide the data related to 2011 in order to compare changes after the Decree of 2012. Because of this, we compare the data related to 2011 with the data related to 2012 and 2013. When we analyse inter-annual changes, numeric changes can be seen. And from the point of percentage change, it is seen that there was a limited increase. The most significant increase points to fixed investment amount. In 2011, for Region 1, the fixed investment amount was 36.13% in 2011 and 38.83% in 2012 and increased to 44.95% in 2013. If we look at this convention in terms of the goal of eliminating regional imbalances, we can state that a limited increase appeared. In 2011, for Region 6, the fixed investment amount was 5.07% in 2011, 8.08% in 2012 and increased to 12.48% in 2013. In the

Chapter Six

Foreign capital 173 201 191 207 188 135 172 182 164 207 208 236 240 20

Domestic capital 1,878 2,493 3,125 3,383 3,725 2,720 2,572 2,770 2,138 3,896 4,161 4,070 4,738 366 2,051 2,694 3,316 3,590 3,913 2,855 2,744 2,952 2,302 4,103 4,369 4,306 4,978 386

Total

Fixed Investment Amount (Million TL) Foreign Domestic Total capital capital 3,547 8,822 12,368 1,652 11,026 12,678 955 11,767 12,722 4,673 12,084 16,757 3,840 13,865 17,704 1,618 13,673 15,291 4,080 18,052 22,132 5,570 19,355 24,924 11,615 15,493 27,108 7,715 54,753 62,469 9,373 44,198 53,571 7,189 50,456 57,645 13,186 80,600 93,785 2,339 3,623 5,962

Source: Republic of Turkey Ministry of Economy, 2014

*Until January 31, 2014

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014*

Years

Number of Incentive Certificate

Table 6-11: Investment incentive statistics between 2001 and 2014

122

Foreign capital 14,537 23,559 14,266 34,567 29,005 17,800 22,819 21,144 16,428 16,911 9,277 14,689 16,547 3,639

Domestic capital 91,194 115,482 133,558 131,109 142,020 97,140 99,932 89,567 68,948 132,110 115,704 132,244 173,460 11,241

Employment

105,731 139,041 147,824 165,676 171,025 114,940 122,751 110,711 85,376 149,021 124,981 146,933 190,007 14,880

Total

Number of Incentive Certificate (NIC) Foreign Domestic Total capital capital 41 434 475 106 1,784 1,890 79 1,438 1,571 115 1,967 2,082 130 2,808 2,938 11 210 221

Fixed Investment Amount (FIA) (Million TL) Foreign Domestic Total capital capital 1,261 4,167 5,427 1,952 21,001 22,953 1,448 12,169 13,617 2,969 22,115 25,084 5,489 30,942 36,431 144 2,045 2,189

Source: Republic of Turkey Ministry of Economy, 2014

*Until the date 31.01.2014

2009 2010 2011 2012 2013 2014*

Years

Table 6-12: Application results of regional investment incentives (2009-2014)

Domestic capital 27,580 80,900 56,300 89,209 125,010 8,152

123

32,154 89,685 61,352 98,121 133,922 9,093

Total

Employment (Emp.) Foreign capital 4,574 8,785 5,052 8,912 8,912 941

The Effects of Tax Incentives on Regional Economic Development

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2,400 17.63 1,591 11.68 759 5.57 690 5.07 34 0.25 13617

23.67

20.24

279 18.39 252 16.61 136 8.97 154 10.15 3 0.20 1517

4,920 36.13 3,223

FIA

386 25.44 307

NIC

2011

8,345 13.60 8,673 14.14 5,865 9.56 4,884 7.96 45 0.07 61352

20.39

21,032 34.28 12,508

Emp.

413 19.84 274 13.16 183 8.79 358 17.20 4 0.19 2082

16.52

506 24.30 344

NIC

3,991 15.91 2,052 8.18 2,106 8.40 2,026 8.08 39 0.16 25084

20.46

9,739 38.83 5,131

FIA

2012

12,967 13.22 10,109 10.30 8,142 8.30 20,973 21.37 8 0.01 98121

11.93

34,219 34.87 11,703

Emp.

435 14.81 381 12.97 333 11.33 615 20.93 9 0.31 2938

14.57

737 25.09 428

NIC

Source: Republic of Turkey Ministry of Economy, 2014

FIA

2013

3,828 10.51 4,219 11.58 2,346 6.44 4,546 12.48 116 0.32 36430

13.72

16,375 44.95 5,000

*NIC: Number of Incentive Certificates, FIA: Fixed Investment Amount (Million TL), Emp.: Employment

3.region % 4.region % 5.region % 6.region % Assorted % Total No

1.region % 2.region %

Regions

Table 6-13: Regional investment incentive distribution inter-regions (2011-2013)

124

14,394 10.75 14,002 10.46 14,496 10.82 32,931 24.59 317 0.24 133922

12.52

41,015 30.63 16,767

Emp.

Foreign capital 112 43 40 21 11 12 1

Domestic capital 1,675 764 664 498 477 635 25 1,787 807 704 519 488 647 26

Total

Number of Incentive Certificate

Fixed Investment Amount (Million TL) Foreign Domestic Total capital capital 5,674 22,945 28,619 2,449 14,735 17,184 2,196 8,692 10,887 354 9,687 10,041 1,128 4,649 5,778 1,360 6,465 7,824 24 13,427 13,451

Source: Republic of Turkey Ministry of Economy, 2014

1.region 2.region 3.region 4.region 5.region 6.region Assorted

Regions

Table 6-14: All types of investment incentive distribution inter-regions (2013)

Foreign capital 5,560 2,674 2,205 1,136 3,040 1,929 3

The Effects of Tax Incentives on Regional Economic Development

Domestic capital 61,111 26,612 19,630 16,181 16,823 31,462 1,641

Employment

66,671 29,286 21,835 17,317 19,863 33,391 1,644

Total

125

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context of regional investment incentive, the lion’s share still belongs to Region 1. But the convention which points to a tendency to leading investment into Region 6, in particular, is an encouraging result for the future. Table 6-14 presents summary evidence on the given investment incentive involving general, regional, large scale and strategic investment, for the regional incentive scheme. We observe that both foreign and domestic capital investors are still doing business in Region 1. But, as also based on Table 6-13, investors have begun to make their investments in less developed regions. Table 6-14 presents this with regards to domestic capital employment data. In Region 1, the domestic capital employment number is 61,111 and its rank number is one, and Region 6 domestic capital employment number is 31,462 and its rank number is two. A survey introduced by the American Business Forum for Turkey shows that 42% of respondents believe that the government’s investment incentives are inadequate to bolster further investment in the country (Ernst and Young, 2013, p. 34). The survey can demonstrate that, in the future, foreign capital coming to invest in Turkey will increase. In fact, these incentives provide a significant opportunity for investments to increase in less developed regions of Turkey, such as Regions 5 and 6, especially when compared with previous incentive programs. The new system creates several incentives across the regions and options for sector prioritization. In Turkey, however, the paucity of data on investments related to incentive, having only one set of data on the existence of current values, makes it difficult to do a healthy analysis. When evaluating the structure of tax incentives on regional economic development, it can be seen that the new investment incentive seems to satisfy the wide array of demands and to take into account for the views of different sectors (Acar and Ça÷lar, 2012:8). Because of this, its chance of success has increased. It has the potential to make investment attractive for investors.

Conclusion Despite the controversy about using tax incentives as a tool, there is a huge movement toward tax incentives all over the world. Providing that incentives are given to less developed regions in the country, it appears to be an opportunity to shift resources into more productive areas. An incentive system which takes into account regional imbalances should aim

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to apply different support in less developed regions from other regions in terms of transferring investment to the backward areas. In developing countries such as Turkey, one of the major economic problems is the inequality in the level of economic development among regions. For this purpose, tax incentives are applied to foster new investment and increase economic development. Every country in the world has its own systems and instruments for improving regional economic development. In this respect, Turkey ensures various incentives in order to overcome regional imbalances and to facilitate regional economic development. Today, incentive systems are being reshaped by the impact of globalisation. When the effectiveness of past applications of tax incentives is analysed, it is seen that the goals set forth by incentives are not realised and cannot be used efficiently for the purpose of regional development. The absence of an effective control and problems in the planning process, including bureaucratic transactions’ redundancy and complexity, played a role in these results. From the 2000s, the precursor regulation in 2009 and the last regulation in 2012 gave a place to sectoral-based regulations. In the context of the given sectoral-based arrangements, several sectoral support elements vary from Region 1 to Region 6. This new incentive available in Turkey is expected to impact regional economic development and in so much to overcome the problem of regional imbalances. It also aims to decrease current account deficits and to increase the added value of production. The last arrangement in the incentive system in Turkey is very new. It’s one of the main policy goals ensuring regional economic development. The tax incentives introduced by the law should be significant for investors and have the potential to achieve the established economic goals. The effectiveness of any investment tax incentive depends on some indicators. First of all, a tax incentive system should be designed considering the country’s economic, social, administrative and political conditions. Then, a tax incentive system should not contain uncertainties. Therefore, it is important to select the correct tax instruments for ensuring regional economic development. The selection must depend on a systematic policy analysis to encourage deliberative outcomes. The important thing is that the tax incentives not only increase investment but also really help the government to achieve its economic goals. In this overview as a tool for ensuring regional economic development, the possible effects of tax incentives have been analysed. Considering the

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potential of tax incentives can lead the way in helping Turkey‘s regional economic development goals. Thus, if the Turkish government can carry out the necessary structural changes and use the incentive tools effectively, the investment incentive tools can be a propellant power in helping Turkey’s regional economic development goals to succeed in the future.

References Acar, O., & Ça÷lar, E. (2012). An Assessment on The New Incentive Package. Economic Policy Research Foundation of Turkey, Research Note Retrieved from http://www.tepav.org.tr/upload/files/13366537594.An_Assessment_ on_the_New_Investment _Incentive_Package.pdf. Akpnar, R. (2004). Bölgesel Geliúme Dinamikleri ve Kurumsal Yansmalar: Yerel Büyüme Koalisyonlar/Bölgesel Kalknma Ajanslar Deneyimi. DPT Planlama Uzmanl÷ Tezi, Ankara. Akdeve, E. & Karagöl, E. (2013). Geçmiúten Günümüze Türkiye’de Teúvikler ve Ülke Uygulamalar. Dumlupnar University Journal of Social Sciences, 37, 329- 350. Bolnick, B. (2004). Effectiveness and Economic Impact of Tax Incentives in the SADC Region. USAID Technical Report February. Duran, M. (2002). Türkiye’de Yatrmlara Sa÷lanan Teúvikler ve Etkinli÷i. Hazine Müsteúarl÷ Araútrma ønceleme Dizisi. Ankara. Edizdo÷an, N. and Çelikkaya, A. (2012). Vergilerin Ekonomik Analizi. Bursa: Dora Yaynlar. Ernst, & Young (2013). Ernst&Young Attractiveness Survey: Turkey 2013 (The shift, the growth and the promise). Retrieved from http://www.ey.com/Publication/vwLUAssets/ Turkey_attractiveness _survey_2013/$FILE/turkey_ attractiveness_2013.pdf. General Directorate of Revenue Policies. (2012). Turkey’s Investment Incentives System. Retrieved from http://www.gep.gov.tr/tmp/_Gep2.pdf. Gümüú, E. (2013). Son De÷iúiklikler Çerçevesinde Yeni Teúvik Sistemi. Mali Çözüm, January- February, 89- 132. Hasano÷lu, M., & Aliyev, Z. (2006). Avrupa Birli÷i ile Bütünleúme Sürecinde Türkiye'de Bölgesel Kalknma Ajanslar. Journal of Turkish Court of Accounts, January- March, 60, 81-105. Kara, M. (2008). Bölgesel Rekabet Edilebilirlik Kavram ve Bölgesel Kalknma Politikalarna Yansmalar, DPT Ekonomik Modeller ve Stratejik Araútrmalar Genel Müdürlü÷ü Uzmanlk Tezi, DPT Yayn No: 2774, August.

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Karabçak, M. (2013). Türkiye’de Uygulanan Ekonomik Teúvik Politikalarnn Boyutu, Ulusal, Bölgesel ve Yerel Kalknma Üzerine Olas Etkileri. The Journal of Faculty of Economics and Administrative Sciences, 18 (3), 263- 280. KPMG (2012). The New Investment Incentives in Turkey, Retrieved from http://www.kpmg.com/TR/en/ Issues AndInsights/ArticlesPublications/Documents/The%20New%20Invest ment%20Incentives%20in%20Turkey_.pdf. Kumral, N. (2006). Bölgesel Rekabet Gücünü Arttrmaya Yönelik Politikalar, Bölgesel Kalknma ve Yönetiúim Sempozyumu Bildiriler Kitab (7-8 September), 275-87. Official Gazette (2012). Decree on State Incentives in Investments. Decree Number: 2012/3305, Number: 28328, Retrieved from http://www.invest.gov.tr/en-US/infocenter/publications/Documents/ DECREE-ON-STATE-INCENTIVES-IN-INVESTMENTS.pdf. Özker, N. & Biniú M. (2010). Vergi Uygulamalarnda Bölgesel Kalknma Hedefleri ve Bölgesel Mali Teúvikler Açsndan De÷erlendirilmesi, The Journal of Social and Economic Research, 13 (19), 491-508. Pnar, Abuzer (2006). Maliye Politikas Teori ve Uygulama. Ankara: Naturel Yaynclk. Republic of Turkey Ministry of Economy (2012). A New Investment Incentive Scheme for Turkey, Retrieved from http://www.economy.gov.tr/index.cfm?sayfa=44F11798-C3E9-A72F1EA3A3E49 01D989D. —. (2014). Investment Incentive Statistics. Retrieved from http://www.ekonomi.gov.tr/index.cfm?sayfa=EE7EE7B1-D8D3-856645201CE77E5 F0FDD. Republic of Turkey Ministry of Development (2013). Tenth Development Plan (2014 - 2018). Retrieved from http://www.kalkinma.gov.tr/Lists/Kalknma%20Planlar/Attachments/12 /onuncu_kalknnma_ plan. pdf. Revenue Administration (2014a). Tax Incentives in Turkey. Retrieved from http://www.gib.gov.tr/ index.php?id=533. —. (2014b). Tax Incentives in Turkey. Retrieved from http://www.gib.gov.tr/ index.php?id=1299. Sakal, M. (2010). Bölgesel Kalknma Sürecinde Kalknma Ajanslar. øzmir. Savrul Klnç, B., & Do÷ru, B. (2013). TR 22 Düzey 2 Bölgesinin 2012 Yl Teúvik Sistemi Çerçevesinde De÷erlendirilmesi, Çankr Karatekin University the Journal of Faculty of Economics and Administrative Sciences, 3 (1), 1- 20.

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Siverekli Demircan, E. (2003).Vergilendirmenin Ekonomik Büyüme ve Kalknmaya Etkisi. Journal of Faculty of Economics and Administrative Sciences, 21, 97-116. Tanröven, I. (1989). Vergi Teúvikleriyle Hazinenin Kaybna Karúlk Ekonominin Sa÷lad÷ Faydalarn Mukayesesi, østanbul University the Journal of Faculty of Economics, 47 (1-4), 331-344. Tezcan, K., & Çukurçayr, S. (2011). Bölgesel Kalknmada Vergisel Teúviklerin Rolü ve Etkinli÷i. Journal of Vergi Dünyas, 31 (36), 117134. Türk, I. (2008). Kamu Maliyesi. Ankara: Turhan Kitabevi. Yavan, N. (2011). Bölgesel Teúviklerin Ekonomik Büyüme Üzerindeki Etkisi: Ampirik Bir Analiz. Ekonomik Yaklaúm, 22 (81), 65-104. Yayar, R., & Demir, Y. (2012). Bölgesel Kalknma ve Yatrm Teúvikleri: Tokat ølinde Bir Uygulama. Erciyes University the Journal of Faculty of Economics and Administrative Sciences, 59, 119-141.

Notes i

Transition period applications comprise the following (Numbered 5479 law, temporary article 69):

x Exclusions which were not deductible before the date of January 1, 2006, by reason of insufficient earnings in previous years,

x Exclusions which were calculated on account of investment expenditures

x

ii

that begun by January 1, 2006 within the context of incentive certificates based on applications submitted before the date of April 24, 2003, in investments which begun within the framework of Additional Articles1-6 of the Income Tax Law abolished previously, Exclusions which were calculated on account of investment expenditures following this date, given that providing economic and technical integrity with investments began before the date of January 1, 2006 within the scope of Article 19 of Income Tax law.

These certifies are itemized below:    

Delivery of sea, air and railway vehicles, Delivery of floating system and vehicles, Delivery and services done concerning the manufacture and construction of these vehicles, Modification, maintenance and repair services of these vehicles made to the taxpayers whose businesses are leasing or operating sea, air and railway vehicles, floating system and vehicles in various forms are excluded from value added tax.

The Effects of Tax Incentives on Regional Economic Development iii

The incentive will be applied as follows:    

iv

131

Profits derived from software development and R&D activities are exempt from income and corporate taxes until December 31, 2023, Deliveries of application software produced exclusively in TDZs are exempt from VAT until December 31, 2023. Wages of researchers along with software and R&D personnel employed in the zone are exempt from personal income tax until December 31, 2023, 50% of the employer’s share of the social security premium will be paid by the government for 5 years until December 31, 2024.

These areas are defined as below:

 Tourism investments in Cultural and Touristic Preservation and Development Regions determined by the Council of Ministers Decree,

 Mining extraction investments and mining processing investments,  Railroad and maritime transportation investments,  Specific pharmaceutical investments and defense Industry investments with minimum investment amount of 20 Million TL,

 Test facilities, wind tunnels and similar investments made for automotive, space or defense industries,

 International fairground investments with a minimum covered area of 50.000 square meter,

 Preschool, Primary, Middle and High School investments by private sector,  Investments made to produce products developed by an R&D Project which is supported by the Ministry of Science, Industry and Technology, Small and medium-sized enterprises Development Organization and TÜBITAK.  Minimum 300 Million TL investment in the Motor Road Vehicles Main Industry and minimum 75 Million TL investment in engine and also Minimum 20 Million TL investment in the engine parts, transmissions and transmission parts and automotive electronics,  Investment on coal fired electricity power plant.

CHAPTER SEVEN CAUSAL RELATIONSHIP BETWEEN TRADING VOLUME AND SECURITY RETURNS: A CASE STUDY OF THE SOUTH EASTERN EUROPEAN REGION JASMINA OKIýIû

Abstract This chapter discusses the dynamic relationship between trading volume and security returns across the selected stock markets operating in the South-Eastern European (SEE) region. The research on the issue of return-volume relationship stresses a common belief that there is a positive relationship between returns and trading volume in the stock markets. Therefore, this chapter seeks to ascertain the impact of information about trading volume on security returns, and vice versa, in the SEE region. As a representative of this region, securities included in the South-Eastern Europe Traded Index (SETX), as a tradable benchmark, were used. Results presented in this chapter have shown that security returns and daily trading volume move together over the long run, while providing for the possibility of short-run divergence. Since divergence often precedes the end of the market trend, the main practical consequence of these results is that investors can make trading volume-based strategies to make profits. Keywords: Trading volume, security returns, causality

Introduction According to Karpoff (1987), there are many reasons why the understanding of the relation between stock prices and volume is important. First, the empirical relation between returns and volume helps discriminate between competing theories on how information is disseminated in financial markets. Second, for event studies that use

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combinations of return and volume data to infer the information content of the event in question, the construction of the tests and the validity of the inferences depend on the joint distribution of returns and volume. Third, the return–volume relation is critical in assessing the distribution of returns themselves. Fourth, a better understanding of the statistical structure of volume and return can help explain technical analysis. Beyond these rationales, the price–volume relation can also be used to validate two wellknown Wall Street adages: (1) volume is relatively heavy in bull markets and light in bear markets, and (2) it takes volume to make prices move. The analysis of trading volume and its relationship with security return is a topic that has been considered for over 50 years. Its roots are generally credited to the work of Osborne (1959) who began a long line of work that considered the possible relationship between returns and the volume of trading. A relationship refers to the correspondence between variables. When we talk about types of relationships, we can mean that in at least two ways, i.e. the nature of the relationship or the pattern of it. The nature of the relationship can be correlational or causal. A correlational relationship simply says that two variables perform in a synchronized manner, but correlation does not imply causation. This is a phrase in science and statistics that emphasises that a correlation between two variables does not necessarily imply that one causes the other. Furthermore, there are two patterns of relationship, i.e. existence and nonexistence of one. If there is no relationship, this means that knowing the values on one variable is not helpful in describing, predicting or explaining the values on the other. If the relationship exists, then there are two cases: (1) positive relationship: high/low values on one variable are associated with high/low values on the other and (2) negative relationship: high values on one variable are associated with low values on the other. This chapter discusses the dynamic relationship between trading volume and security returns across the selected stock markets from the South-Eastern European (SEE) region. The research on the issue of return–volume relationship stresses a common belief that there is a positive relationship between returns and trading volume in the stock markets. Therefore, this chapter seeks to ascertain the impact of information about trading volume on security returns in the SEE region and vice versa. The research should result in responses to the following questions: what are the specificities of the selected stock markets in the South Eastern European region? Is there a significant correlation between security returns and daily trading volume changes in case of blue chips from these

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markets? Is there a causal relationship between security returns and daily trading volume changes in case of blue chips from these markets? Having in mind the above stated, the central research hypothesis shall be as follows: security returns and daily trading volume changes move together over the long run, while providing for the possibility of short-run divergence. Divergence occurs when the return and trading volume move in opposite directions. The simplest example of divergence is a clear upward trend on declining volume. By examining and analysing the relationship between security returns and daily trading volume changes, the chapter is designed to shed some light on important issues such as market structure and information arrival, market efficiency, etc. The chapter is organized as follows. After the introduction, part one gives a short overview of some recent literature that is relevant to the main objective of the chapter. Part two outlines the research methodology. Part three is the centre of the chapter and contains analysis and discussion of the original empirical results. The last part contains some final remarks and conclusions.

Literature review Studies on the relationship between daily trading volume changes and security returns go back to the 1950s. Osborne (1959), by modelling price changes according to a diffusion process that had a variance dependent on the quantity of transactions on that particular issue, proposed a theoretical relation between volume and price. Although there has been extensive research into the empirical and theoretical aspects of the stock price– volume relation, most of these studies have focused almost exclusively on well-developed financial markets, usually the United States (U.S.) markets. However, in the last decade emerging and frontier markets are also becoming more and more interesting for analysis, especially in the case of relationship between return and trading volume. For example, Assogbavi and Osagie (2006) examined the stock price–volume relationship in emerging markets throughout the world. They reported strong evidence on stock price changes leading trading volume. Pathirawasam (2011) examined the relationship between trading volume and stock returns regarding a sample of 266 stocks traded at the Colombo Stock Exchange (CSE) from 2000 to 2008. The study revealed that stock returns are positively related to the contemporary change in trading volume. Further, it was found that past trading volume change is negatively related to stock returns. Chakrabarti, Huang, Jayaraman and Lee (2005) documented the effect of changes in a widely used set of country equity indices, the MSCI

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135

country indices, on the returns and trading volumes of stocks added to or removed from these indices around the event dates. There was clear evidence of an impact on returns, as well as on trading volumes, on these stocks for the non-U.S. countries understudy. Darwish (2012) tested the contemporaneous and causal relationship between trading volume and return in the Palestine exchange. The results of the Granger causality test documented bidirectional Granger causality between returns and trading volume, regardless of the measures of trading volume used. Khan and Rizwan (2008) investigated empirical contemporaneous and causal relationships between stock returns, trading volume and volatility of stock index in Pakistan’s stock market. They found a feedback relationship between stock returns and trading volume, i.e., returns cause volume and volume causes returns. Chordia and Swaminathan (2000) found that trading volume is a significant determinant of the lead-lag patterns observed in stock returns. Tripathy (2011) examined the relationship between price changes and trading volume in the case of the Indian stock market. The study has shown that there is a bi-directional causality between trading volume and stock return volatility. Saatcioglu and Starks (1998) examined the stock price–volume relationship in emerging stock markets in Latin America. They reported a positive relation between volume and both the magnitude of price change and price change itself. Kamath (2008) investigated the econometric relations between daily returns and daily trading volume changes on the Santiago Stock Exchange of Chile in which a significant contemporaneous relation between volume and returns was reported. Moreover, the results supported the notion that the trading volume makes the market move. The causality test results provided clear evidence of daily returns Granger causing daily trading volume changes in the Chilean equity market. In recent literature there is little evidence on the relationship between daily trading volume changes and security returns in the case of underdeveloped stock markets from the SEE region.

Data As a representative of the SEE region, countries included in the SouthEastern Europe Traded Index (SETX), as a tradable benchmark for the SEE region, were used. The SETX is one of the CEE and CIS indices of the Vienna Stock Exchange that covers the countries Slovenia, Croatia, Serbia, Bulgaria and Romania. According to the FTSE quality of markets criteriai, these countries are classified as frontier markets. Specificities of these markets are presented in Table 7-1.

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Table 7-1: FTSE quality of markets criteria (EUROPE Frontier) in March 2014 Criteria

Country Bulgaria

Croatia

Romania

Serbia

World Bank GNI Per Capita Rating, 2012 Credit Worthiness Market and Regulatory Environment Formal stock market regulatory authorities actively monitor market (e.g., SEC, FSA, SFC) Fair and non-prejudicial treatment of minority shareholders Non or selective incidence of foreign ownership restrictions No objection to or significant restrictions or penalties applied to the investment of capital or the repatriation of capital and income Free and well-developed equity market Free and well-developed foreign exchange market Non or simple registration process for foreign investors Custody and Settlement Settlement – Rare incidence of failed trades Custody-Sufficient competition to ensure high quality custodian services Clearing and settlement –T+3, T+5 for Frontier Stock Lending is permitted

Upper middle Investment

High Speculative

Upper middle Speculative

Upper middle Speculative

Pass

Pass

Pass

Pass

Pass

Pass

Restricted

Pass

Pass

Pass

Pass

Pass

Pass

Pass

Pass

Pass

Not met

Not met

Not met

Not met

Not met

Not met

Not met

Not met

Restricted

Restricted

Restricted

Restricted

Pass

Pass

Pass

Pass

Pass

Pass

Pass

Pass

T+2

T+3

T+3

T+3

Restricted

Not met

Not met

Not met

Causal Relationship between Trading Volume and Security Returns Settlement – Free Restricted Restricted delivery available Custody – Omnibus Not met Pass account facilities available to international investors Dealing Landscape Brokerage – Sufficient Pass Pass competition to ensure high quality broker services Liquidity – Sufficient Not met Not met broad market liquidity to support sizeable global investment Transaction costs – Pass Pass Implicit and explicit costs to be reasonable and competitive Short sales permitted Restricted Not met Off-exchange Pass Pass transactions permitted Efficient trading Pass Pass mechanism Transparency – market Pass Pass depth information/visibility and timely trade reporting process Derivatives Developed Derivatives Not met Not met Market Size of Market Market Capitalization 7,018 21,442 USD (from 31st Dec, 2013) Total Number of Listed 381 220 Companies (as at 31st Dec 2013) Source: FTSE International Limited (2014)

137

Restricted

Pass

Restricted

Not met

Pass

Pass

Not met

Not met

Restricted

Pass

Restricted Not met

Not met Pass

Pass

Pass

Pass

Pass

Restricted

Not met

24,574

3,943

81

997

The SETX consists of blue chip stocksii traded on stock exchanges in the SEE region. The structure of the SETX is presented in Table 7-2.

Symbol ADRS-P-A AIKB TLV BRD ERNT-R-A FP HT-R-A KRKG MELR NIIS SNP PTKM-R-A PETG 3JR TLSG TEL TGN ZVTG

Blue chips

ADRIS GRUPA P AIK BANKA BANCA TRANSILVANIA BRD-GROUPE SG ERICSSON NIKOLA TESLA FONDUL PROPRIETATEA HRVATSKI TELEKOM KRKA MERCATOR NIS OMV PETROM PETROKEMIJA PETROL SOPHARMA TELEKOM SLOVENIJE TRANSELECTRICA TRANSGAZ TRIGLAV Source: Wiener Börse AG (2014)

Table 7-2: Structure of the SETX

138

Croatia Republic of Serbia Romania Romania Croatia Romania Croatia Slovenia Slovenia Republic of Serbia Romania Croatia Slovenia Bulgaria Slovenia Romania Romania Slovenia

Country

Chapter Seven

6,784,100 9,045,756 2,206,436,324 696,901,518 1,331,650 13,778,392,208 81,888,535 35,426,120 3,765,361 163,060,400 56,644,108,335 3,341,117 2,086,301 132,000,000 6,535,478 73,856,084 11,773,844 22,735,148

Number of shares

Capitalization EUR 234,629,058 68,336,674 504,251,003 331,026,279 167,682,320 1,284,537,496 885,600,633 1,311,209,266 125,424,175 254,271,691 363,989,698 17,387,457 388,615,287 124,194,002 345,203,948 50,603,314 103,725,846 206,435,144

Index portion 3.47% 1.01% 7.45% 4.89% 2.48% 18.98% 13.09% 19.38% 1.85% 3.76% 5.38% 0.26% 5.74% 1.84% 5.10% 0.75% 1.53% 3.05%

Starting date for SETX was 03 January, 2005. Our observation period covers the time frame from the effective dateiii (of every issuer) to the end of March 2014.

Methodology For the purpose of modelling, instead of original price data, certain transformations will have to be made. So, if we denote successive price observations made at time t and t+1 as Pt and Pt+1, respectively, then continuous compounding transforms a price series {Pt} into a return series {rt} as:

rt

ln

Pt Pt 1

(1)

Also, if we denote successive daily trading volume observations made at time t and t+1 as Vt and Vt+1, respectively, then continuous compounding transforms a trading volume series {Vt} into a daily trading volume change series {vt} as:

vt

ln

Vt Vt 1

(2)

If the change in trading volume carries information on stock returns, there should be a significant relationship between change in volume and stock returns. To test whether trading volume precedes stock returns, or vice versa, the following vector autoregressive (VAR) model is used in this study (Khan and Rizwan, 2008):

rt vt

m

n

i 1

i 1

m

n

i 1

i 1

D1  ¦ E i1vt i  ¦ J i1rt i  H i1 D 2  ¦ E i 2 rt i  ¦ J i 2 vt i  H i 2

.

(3)

In the previous model, rt and vt denote daily stock return and daily trading volume change, respectively. Intercepts are Į1 and Į2 , and ȕi1, Ȗi1, ȕi2, Ȗi2 are parameters, m and n are the lag lengths for returns and trading volume to be used in the equation.

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In order to estimate a VAR model, the number of lags of endogenous variables has to be determined first, as the results and hence inferences from estimation can be very sensitive to the lag choice (Yangru and Zhou, 2010). The appropriate order of the model can be chosen by minimizing the Akaike’s information criterion (AIC):

AIC

 2 LOGl  2 m .

(4)

in which L is the likelihood of the model and m is the number of parameters estimated. Next, the presence of a long-term equilibrium relationship is tested by using the Johansen procedure for testing the presence of cointegration between daily return and daily trading volume change. The first test involves a null hypothesis of no cointegrating vectors (r). If this null is not rejected, it would be concluded that there are no cointegrating vectors and the testing would be completed. However, if H0: r=0 is rejected, the null that there is one cointegrating vector (i.e. H0: r=1) would be tested, and so on. Thus the value of r is continually increased until the null is no longer rejected (Brooks, 2008). Furthermore, in order to examine the existence of short-term causal relationships the Granger causality test was used. This test is designed to examine whether two time series move one after the other or contemporaneously. When they move contemporaneously, one provides no information for characterizing the other. The main purpose of the Granger causality test (H0: x does not Granger Cause y) is to see how much of the current y can be explained by past values of y and then to see whether adding lagged values of x can improve the explanationiv. Furthermore, ‘y is said to be Granger caused by x if x helps in the prediction of y, or equivalently if the coefficients on the lagged x’s are statistically significant. (…) The statement “x Granger causes y” does not imply that y is the effect or the result of x. Granger causality measures precedence and information content but does not itself indicate causality in the more common use of the term’ (Quantitative Micro Software, 2009).

Causal Relationship between Trading Volume and Security Returns

141

Results and discussion According to the previously explained research design, the next section presents the relevant results of correlational and causal relationship between daily securities return and trading volume changes in the case of the stock markets from the SEE region. The correlation between two variables indicates the level to which those variables move together. In the case of statistical significance of correlation coefficient (ȡ), the following hypotheses are tested: H0: ȡ=0, H1: ȡ0. Results of the correlation analysis are presented in Table 7-3. Table 7-3: Correlation between return and trading volume change Blue chips

Correlation between return and volume change

Blue chips

Correlation between return and volume change

Pearson Correlation

Sig. (2tailed)

ADRSP-A

0.007

0.809

PETG

0.034

AIKB

0.069*

0.033

PTKMR-A

0.061*

BRD

0.013

0.469

SNP

0.033

ERNTR-A

0.037

0.103

TEL

0.062**

FP

0.048

0.174

TGN

-0.004

HT-RA

0.048

0.053

TLSG

0.030

KRKG

0.037

MELR NIIS

Pearson Correlation

0.100

TLV

0.022

0.078

**

0.000

ZVTG

0.017

0.145

**

0.000

3JR

-0.023

**. Correlation is significant at the 0.01 level (2-tailed); *. Correlation is significant at the 0.05 level (2-tailed).

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142

In general, it can be concluded that there is a positive, but low, significant correlation between trading volume change and security returns. Only TGN and 3JR had negative, but statistically not significant, correlation between daily trading volume changes and security returns. The results of estimated VAR models are presented in Table 7-4. Table 7-4: Evaluation of the estimated VAR models (rt and vt) VAR model evaluation:

ADRS-P-A VAR models:

AIKB VAR models:

R-squared Adj. R-squared F-statistic AIC VAR model evaluation:

rt vt 0.100328 0.013533 0.091241 0.003569 11.04013 1.358165 -4.227429 11.33891 ERNT-R-A VAR models:

rt vt 0.087692 0.418825 0.067940 0.406242 4.439589 33.28507 -4.641564 4.098153 FP VAR models:

R-squared Adj. R-squared F-statistic AIC VAR model evaluation:

rt vt 0.022824 0.346353 0.012457 0.339418 2.201452 49.94094 -4.740943 3.084743 KRKG VAR models:

rt vt 0.017892 0.312440 0.002626 0.301752 1.172018 29.23420 -5.545583 2.111466 MELR VAR models:

R-squared Adj. R-squared F-statistic AIC VAR model evaluation:

rt vt 0.015082 0.362322 0.005967 0.356421 1.654649 61.39615 -5.442055 3.010571 PETG VAR models:

rt vt 0.013222 0.354768 0.006968 0.350679 2.114333 86.76304 -5.070374 3.076939 PTKM-R-A VAR models:

R-squared Adj. R-squared F-statistic AIC VAR model evaluation:

rt vt 0.006229 0.403365 0.000089 0.399679 1.014564 109.4214 -5.369095 3.151829 TEL VAR models:

rt vt 0.011165 0.359399 -0.003240 0.350067 0.775061 38.51102 -4.327241 3.196387 TGN VAR models:

rt

rt

vt

vt

BRD VAR models: rt 0.027080 0.021442 4.802942 -4.457491 HT-R-A VAR models: rt 0.010058 -0.002569 0.796554 -5.774503 NIIS VAR models: rt 0.062267 0.040124 2.812107 -5.446010 SNP VAR models: rt 0.014067 0.005625 1.666201 -4.406903 TLSG VAR models: rt

Causal Relationship between Trading Volume and Security Returns R-squared Adj. R-squared F-statistic Akaike AIC VAR model evaluation:

0.022554 0.011748 2.087114 -4.657365 TLV VAR models:

0.363390 0.356352 51.63068 3.044464

0.029848 0.020583 3.221700 -4.919579 ZVTG VAR models:

0.352455 0.346271 56.99533 2.961940

R-squared Adj. R-squared F-statistic AIC

rt 0.012499 0.006959 2.255884 -4.217619

vt 0.255661 0.251485 61.21479 2.681192

rt 0.032998 0.017119 2.078123 -4.773808

vt 0.407371 0.397639 41.86237 3.682019

143

0.010845 0.001675 1.182688 -5.209486 3JR VAR models: rt 0.010643 0.002162 1.254895 -3.072661

According to the results presented in Table 7-4, it is evident that in the case of all estimated VAR equations, daily trading volume change is better explained by daily return than daily return is by trading volume. The next step is testing the presence of long-term equilibrium relationships between daily trading volume change and security returns. In our analysis the Johansen testing procedure was used. Results are presented in Table 7-5. Table 7-5: Results of the Johansen procedure Variables and hypothesized no. of CE(s): Eigen value Trace Trace test: statistics Critical Value Prob.** Max. Maxeigen Eigen value Statistic test: Critical Value Prob.** Variables and hypothesized no. of CE(s): Eigen value

ADRS-P-A None * At most 1*

AIKB None *

0.316783 338.5809

0.215411 131.7293

0.232174 255.5545

0.078377 60.31621

0.170145 857.3993

15.49471

3.841466

15.49471

3.841466

15.49471

0.0001 206.8516

0.0000 131.7293

0.0001 195.2383

0.0000 60.31621

0.0001 582.0791

14.26460

3.841466

14.26460

3.841466

14.26460

0.0001 FP None *

0.0000

0.0001 HT-R-A None *

0.0001 0.0000 ERNT-R-A None * At most 1* 0.167205 0.061759

0.266221

At most 1*

At most 1* 0.117740

BRD None *

0.192893

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144 Trace test:

Trace statistics Critical Value Prob.** Max. Maxeigen Eigen value Statistic test: Critical Value Prob.** Variables and hypothesized no. of CE(s): Eigen value Trace Trace test: statistics Critical Value Prob.** Max. Maxeigen Eigen value Statistic test: Critical Value Prob.** Variables and hypothesized no. of CE(s): Eigen value Trace Trace test: statistics Critical Value Prob.** Max. Maxeigen Eigen value Statistic test: Critical Value Prob.** Variables and hypothesized no. of CE(s): Eigen value

469.0083

121.1864

340.8951

98.21025

475.4117

15.49471

3.841466

15.49471

3.841466

15.49471

0.0001 347.8219

0.0000 121.1864

0.0001 242.6849

0.0000 98.21025

0.0001 340.0918

14.26460

3.841466

14.26460

3.841466

14.26460

0.0001 KRKG None *

0.0000

0.0001 MELR None *

0.0000

0.0001 NIIS None *

0.181160 580.9820

At most 1* 0.092038 15.49471

0.187605 963.9335

At most 1* 0.092342 306.5541

189.2433

3.841466

15.49471

3.841466

15.49471

0.0001 391.7387

0.0000 189.2433

0.0001 657.3795

0.0000 306.5541

0.0001 224.6924

14.26460

3.841466

14.26460

3.841466

14.26460

0.0001 PETG None *

0.0000

0.0001 SNP None *

0.186678 937.4735

At most 1* 0.078485 265.7241

0.0001 0.0000 PTKM-R-A None * At most 1* 0.244157 0.105835 377.2903 107.7257

15.49471

3.841466

25.87211

12.51798

15.49471

0.0001 671.7494

0.0000 265.7241

0.0000 269.5645

0.0000 107.7257

0.0001 426.5974

14.26460

3.841466

19.38704

12.51798

14.26460

0.0001 TEL None *

0.0000

0.0001 TGN None *

0.0000

0.0001 TLSG None *

0.187759

At most 1* 0.097733

0.231359

At most 1* 0.135039

0.228071 282.1148

0.182349 632.4140

0.208484

Causal Relationship between Trading Volume and Security Returns

145

Trace test:

Trace 568.7695 188.2061 602.5065 214.1247 584.5455 statistics Critical 15.49471 3.841466 15.49471 3.841466 15.49471 Value Prob.** 0.0001 0.0000 0.0001 0.0000 0.0001 Max. Max380.5633 188.2061 388.3818 214.1247 405.4180 eigen Eigen value Statistic test: Critical 14.26460 3.841466 14.26460 3.841466 14.26460 Value Prob.** 0.0001 0.0000 0.0001 0.0000 0.0001 Variables and TLV ZVTG 3JR hypothesized no. None * At most None * At most None * of CE(s): 1* 1* Eigen value 0.172784 0.073184 0.189618 0.065293 0.165088 Trace Trace 857.1139 245.1762 341.6593 83.05171 613.1864 test: statistics Critical 15.49471 3.841466 15.49471 3.841466 15.49471 Value Prob.** 0.0001 0.0000 0.0001 0.0000 0.0001 Max. Max611.9377 245.1762 258.6076 83.05171 420.3984 eigen Eigen value Statistic test: Critical 14.26460 3.841466 14.26460 3.841466 14.26460 Value Prob.** 0.0001 0.0000 0.0001 0.0000 0.0001 * denotes rejection of the hypothesis at the 0.05 level, **MacKinnon-HaugMichelis (1999) p-values

Results of the Granger causality test between daily volume trading volume changes and returns are presented in Table 7-6. Results of the Johansen procedure and Granger causality test indicate that selected variables (daily volume trading volume change and return) move together over the long term, while providing for the possibility of short-term divergence. The findings of the current study are consistent with those conducted by Assogbavi and Osagie (2006), Pathirawasam (2011), Khan and Rizwan (2008), Chordia and Swaminathan (2000), Tripathy (2011), Saatcioglu and Starks (1998), etc. Ultimately, this research has confirmed that there is a feedback relationship between security returns and daily trading volume changes, i.e., returns cause volume and volume causes returns.

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146

Table 7-6: Results of the Granger causality test Blue chips ADRSP-A

AIKB

BRD

ERNTR-A

FP

HT-RA

KRKG

MELR

NIIS

H0

Prob.

vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt

0.2590

Blue chips PETG

0.5962 0.0242

PTKMR-A

0.2675 0.1059

SNP

0.0208 0.1210

TEL

0.2656 0.2644

TGN

0.6191 0.8545

TLSG

0.1141 0.3970

TLV

0.0118 0.6814

ZVTG

0.4508 0.4605 0.0046

3JR

H0

Prob.

vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt vt does not Granger Cause rt rt does not Granger Cause vt

0.7081 0.0789 0.9937 0.2892 0.9923 0.9249 0.0188 0.2316 0.9201 0.3016 0.1203 0.0548 0.0045 0.4318 0.0067 0.4638 0.1332 0.7208

Causal Relationship between Trading Volume and Security Returns

147

Conclusion This chapter investigated the dynamic relationship between trading volume and security returns across the selected stock markets from the SEE region. On the basis of theoretical inferences and empirical evidence presented in this chapter, it seems fair to suggest that, in the case of blue chip stocks from the SEE region, security returns and daily trading volume changes move together over the long term, while providing for the possibility of short-term divergence. Basically, this research has confirmed that there is a feedback relationship between security returns and daily trading volume changes, i.e., returns cause volume and volume causes returns. Also, there is evidence of a low positive significant correlation between trading volume changes and security returns. This study produced results which corroborate the findings of a great deal of the previous work in this field. However, due to the relatively small sample of blue chip stocks from the SEE region used, which is the main limitation of the study, more research on this topic needs to be undertaken before the association between security returns and daily trading volume changes is more clearly understood. To summarize, previously formulated scientific hypotheses can be confirmed and further research suggests a need for more in-depth analysis of the selected markets, in terms of their efficiency and structure. The main practical consequence of these results is that, as the trading volume has predictive power on security returns, investors can make trading volume-based strategies to make profits. Volume is the number of securities that trade over a given period of time, and therefore it is a very powerful tool that can be used by the individual or institutional investor. Since volume signals whether there are buyers or sellers for the security in the market, the higher the volume, the more active the security is. On the other hand, return indicates the stock market direction, i.e. bullish or bearish trend. The volume should be rising and be higher when the price is moving in the direction of the trend. If this is not the case, a divergence between volume and return exists. Such a divergence often precedes the end of the trend. Results presented in this study have shown that, in the case of analysed securities, the possibility exists of short-term divergence between volume and return. Since the divergence often precedes the end of the market trend, examining the relationship between volume and return is crucial in an attempt to reduce investment risk.

148

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References Assogbavi, T., & Osagie, J.E. (2006). Equity Valuation Process and Price– Volume Relationship on Emerging Stock Markets. International Business and Economics Research Journal, 5(9), 7–18. Brooks, C. (2008). Introductory Econometrics for Finance. Cambridge: Cambridge University Press. Chakrabarti, R., Huang, W., Jayaraman, N., & Lee, J. (2005). Price and Volume Effects of Changes in MSCI Indices – Nature and Causes. Journal of Banking and Finance, 29(5), 1237–1264. Chordia, T., & Swaminathan, B. (2000).Trading Volume and CrossAutocorrelations in Stock Returns. The Journal of Finance, 55(2), 913–935. Darwish, M. (2012). Testing the Contemporaneous and Causal Relationship between Trading Volume and Return in the Palestine Exchange. International Journal of Economics and Finance, 4(4), 182–192. FTSE International Limited. (2014). FTSE Quality of Markets Criteria (EUROPE Frontier) as at March 2014. Retrieved 1 April 2014, from http://www.ftse.com/Indices/Country_Classification/Downloads/Europ e_Frontier_March_2014.pdf Granger, C. W.J. (1969). Investigating Causal Relations by Econometric Models and Cross-Spectral Methods. Econometrica, 37(3), 301–318. Kamath, R. R. (2008). The Price–Volume Relationship in the Chilean Stock Market. International Business and Economics Research Journal, 7(10), 7–14. Karpoff, J. M. (1987). The Relation between Price Changes and Trading Volume: A Survey. Journal of Financial and Quantitative Analysis, 22(1), 109–126. Khan, S. U., & Rizwan, F. (2008).Trading Volume and Stock Returns: Evidence from Pakistan’s Stock Market. International Review of Business Research Papers, 4(2), 151–162. Kirchgässner, G., & Wolters, J. (2007). Introduction to Modern Time Series Analysis. Berlin: Springer-Verlag. Osborne, M. F. M. (1959). Brownian Motion In the Stock Market. Operations Research, 7(2), 145–173. Pathirawasam, C. (2011). The Relationship between Trading Volume and Stock Returns. Journal of Competitiveness, 3(3), 41–49. Quantitative Micro Software. (2009). EViews 7 User’s Guide I. Irvine, CA. Saatcioglu, K., & Starks, L. T. (1998).The Stock Price-Volume Relationship in Emerging Stock Markets: The Case of Latin America.

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International Journal of Forecasting, 14(2), 215–225. Tripathy, N. (2011). The Relation between Price Changes and Trading Volume: A Study in Indian Stock Market. Interdisciplinary Journal of Research in Business, 1(7), 81–95. Wiener Börse AG. (2014). Index values. Retrieved 30 March 2014, from http://en.indices.cc/indices/details/sxe/composition/ Yahoo! Finance Worldwide. (2014). Market Performance. Retrieved 1 April 2014, from http://finance.yahoo.com/market-overview/ Yangru, W., & Zhou, X. (2010). VAR Models: Estimation, Inferences, and Applications. In: C. Lee et al. (Ed.), Handbook of Quantitative Finance and Risk Management (pp. 1391-1398). New York: Springer Science + Business Media.

Notes i

FTSE Group (FTSE) is a global leader in indexing and analytic solutions. FTSE calculates thousands of unique indices that measure and benchmark markets and asset classes in more than 80 countries around the world. FTSE is wholly owned by London Stock Exchange Group.

ii Real financial time series for all stocks observed in this paper were retrieved from Yahoo! Finance Worldwide (2014). iii

Effective date is the date, declared by the Securities and Exchange Commission, on which stocks can start trading. This usually refers to the date when shares become available for sale in an initial public offering. iv

For more details on Granger causality see Granger (1969) as well as Kirchgässner and Wolters (2007).

CHAPTER EIGHT TWO TRANSITIONS IN CROATIA IVAN LOVRINOVIû, MARKO PRIMORAC AND TEA LOVRINOVIû

Abstract: In its short history, Croatia has undergone tremendous changes. Political changes have brought independence, while in the economy; a transition from a planned to a free-market economy has been effectuated. The transition process was meant to bring greater efficiency and economic growth, as well as to promote entrepreneurship and innovations. However, twenty years later, it seems that the Croatian economy is still “lost in transition”. The main purpose of this article is to provide an overview of the transition and privatisation process in Croatia, as well as to identify the key drawbacks in, and problems related to the privatisation methods used in Croatia. In addition, the chapter deals with the economic circumstances and consequences of the second Croatian transition – the accession to the European Union. The analyses presented in the chapter bear out two essential assumptions. Firstly, the transition and privatisation process in Croatia was extremely harmful for the Croatian economy. Secondly, Croatia entered the European Union unprepared, which made the cost of the accession higher than the benefits. Keywords: transition, privatisation, accession to the EU, Croatia

Introduction Croatia is a young country. However, it has a rich history of political, economic and social transition. The “first transition” process was initiated during the Homeland War, with the gradual establishment of democratic institutions and the transition from a socialist to market economy. Recently, while the process of privatisation was still under way, Croatia joined the European Union (EU). The EU accession and the exposure to

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the single EU market represented the beginning of the “second transition”. Both Croatian transitions were meant to bring economic growth and prosperity to the economy, but the consequences proved to be completely the opposite. Whether the processes were not successful because they were poorly conceived or implemented at the wrong time, or whether they themselves were essentially unsuitable to Croatia, remains an open question. The main purpose of this article is to outline the basic features and economic consequences of the Croatian transition process. Additionally, the chapter provides a comprehensive overview of the characteristics of the privatisation methods used in Croatia and discusses the economic and social problems those methods created. It also deals with the economic consequences of Croatian accession to the European Union and the macroeconomic perspectives in the post-accession period. After the introduction, the second part is devoted to the theoretical background and a literature review. The third part briefly covers the chronology of the transition process in Croatia. The fourth part describes the first transition – from a socialist to market economy and presents the basic features of the employed privatisation model. The main characteristics of the second Croatian transition denoted by the premature and poorly prepared accession to the European Union are discussed in the fifth part. The sixth part concludes the chapter.

Theoretical background The literature on transition and privatisation is vast in both empirical and theoretical terms. Havrylyshyn and McGettigan (1999) succeeded in systematizing the most important literature sources in several categories: the extent of privatisation, privatisation and enterprise performance, different methods of privatisation, the new private sector and the background market environment. Research into the processes of transition and privatisation in Croatia has covered various aspects of the course of transition, from economic, as well as political and social perspectives. Katunariü (2004) provides an overview of Croatian literature dealing with the transition process, including the works of ýuþkoviü, Mihaljek, Šonje, Franiþeviü, Vehovec, Teodoroviü, Baletiü, Biüaniü, Horvat and other prominent researchers.

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Table 8-1. Literature review Topic

Literature

The extent of privatisation

Nellis (1998), World Bank (1996), EBRD (1998), Johnson et al. (1997)

Privatisation and enterprise performance

Frydman et al. (1997), Barberis et al. (1996), Vining and Boardman (1992), Megginson et al. (1994)

Different methods of privatisation

Lipton and Sachs (1990), Lewandowski (1997), Gray (1996), Bornstein (1997), Aghion et al. (1994)

New private sector

Johnson and Loveman (1995), Murrell (1992), Bilsen and Konings (1997), Belka et al. (1995)

Background market environment

Ganiev (1997), Schaffer (1998), Djankov and Hoekman (1997), Rapaczynski (1996)

Source: Authors according to Havrylyshyn and McGettigan (1999)

ýuþkoviü (2001) analyses the transformation of the ownership structure and corporate governance in Croatia. Mihaljek (2000) and Šonje (2001) provide different perspectives on the transition process in Croatia, but have views in common on the factors that had brought about the transition failures, as well as on the ways in which it might be possible to remedy these problems. Franiþeviü (1998) and Vehovec (2002) approach transition problems in Croatia from a macro sociological point of view, claiming that the transition in Croatia should have been based on a more flexible approach that would have allowed the alignment of new formal institutions and old socio-cultural patterns. Teodoroviü (2001) analyses economic aspects of the transition process and provides reasons why Croatia failed to finish the transition process sooner and in a more efficient way. The list of the most important references includes other domestic authors like Baletiü (2001), Baloban (1994), Biüaniü (1993, 1995, 1996 and 2001), Coats and Škreb (2002), Horvat (1995, 1999 and 2002), Kalogjera (1993) and Šonje and Vujþiü (1999). However, the transition in Croatia has also been of interest to researchers from outside the country. For example, Koyama (2003) provided an excellent and objective overview of the transition process, and its economic implications and consequences, as well as of the socio-economic setting in Croatia in the transition period.

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Chronology of the transition process in Croatia The transition process in Croatia evolved through four different subeconomic phases in the period from 1991-2014. The period 1991-1993, which was followed by the economic crisis, marked the beginning of the transition process. The second phase 19941999 is known for the stabilization program, as well as for having halted hyperinflation and achieving a relatively high growth rate. In the third phase, 2000-2007, the growth rates were positive and were accompanied by a relatively low inflation rate (about 3%) and a drop in the unemployment rate (from 16% to 9%). This is the period of the privatisation of commercial banks and of increased credit activity. The last period started in 2008 with the recession, followed by the depression of the Croatian economy. GDP growth rates in this period have been negative and the unemployment rate has been high.

Source: Authors

PERIOD 1 (1991-1993) The beginning of the transition process.

PERIOD 2 (1994-1999) Stabilization program stopping hyperinflation and achieving a relatively high growth rate.

Figure 8-1. Chronology of the transition

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PERIOD 3 (2000-2007) Positive growth rates, a relatively low inflation rate and a drop in the unemployment rate. Privatization of the banks and strong credit activity.

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PERIOD 4 (from 2007) Recession followed by the depression of the Croatian economy – negative rates of GDP growth and high rate of unemployment.

Source: CBS

Note: Data after 2012 are provisional.

* The data refer to the first quarter.

-8

-6

-4

-2

0

2

4

6

8

Figure 8-2. Real GDP rates of change 1991-2007 (in %)

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1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014*

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Key points of the transition in Croatia Stabilization of prices. Croatia inherited high inflation from the former Yugoslavia, and the costs of the war only exacerbated it. Therefore, the stabilization of inflation at a low level was a prerequisite for the process of economic transformation and transition. Price liberalization and the liberalization of foreign trade. The process of globalisation imposed the necessity of price liberalization and greater openness to foreign competition, and was also a precondition for membership in the WTO. Privatisation of state-owned enterprises and banks. Banks in Croatia were burdened with large amounts of non-performing loans and were strongly influenced by politics because they were state-owned. The situation in the large state-owned enterprises was similar. Reform of the financial sector entailed the transformation of the financial system in harmony with the capitalist economic system, which included the development of the capital market, stock ownership and the introduction of new financial institutions. Reform of the social security system. The social security and health insurance systems had a significant share in the state budget. Therefore, it was necessary to align those systems with criteria of sustainability. Reform of the political system. The decision to secede from Yugoslavia was accompanied by the establishment of a multiparty political system aimed at the development of democracy.

Czech R.

Hungary

Sources: Eurostat and CBS.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Poland

Slovak R.

Slovenia

Bulgaria

Figure 8-3. Average real GDP growth in Croatia versus that of peers 2003–2013 (in %)

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Romania

Croatia

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Deficiencies of the transition process in Croatia Poor concept of privatisation. The privatisation process began during the war and this prevented a consistent approach to finding the best privatisation model to be utilised. The situation was exploited by interest groups, which found it possible to push through their respective solutions. War damage was an enormous burden to the state budget, slowing down or even preventing other necessary investments. Wrong monetary and exchange rate policy. Croatia introduced the antiinflation program in 1992 and succeeded in slashing inflation to an acceptable level within a year. However, the problem is that this stabilization program is still being implemented, whereas changes in the economy require new economic policy objectives to encourage the growth of exports, production, employment and GDP. Inefficient judiciary and bad laws. An inefficient legal system has been one of the main obstacles to an effective transformation of the Croatian economy. The main reasons for this are the poor organisational structure and accountability system, as well as weak laws that were imposed and captured by interest groups, and, finally, corruption. Poorly developed institutions. War, the legacy of socialism and lack of knowledge posed obstacles to the faster construction of institutions that would have participated more effectively in the transition and resulted in a higher level of democracy and transparency. Inherited economic structure. The inherited economic structure and the loss of the fairly large, common Yugoslav market, as well as the market of the non-aligned countries led to a significant decline in economic activity. This was compounded by the inability to reorient in time to new markets. Lack of necessary knowledge. Lack of knowledge in all spheres of the economy (management, finance, accounting and marketing) that were required for the construction of capitalism impeded rapid adjustment. Outdated technology. Technology was generally outdated, although there were some companies that were sectoral leaders, such as those in the industrial machinery and agriculture sectors. Risk of "interest groups". It is known that major changes in social relations and the transition from one system to another have always been used by certain interest groups to achieve their, usually criminal, objectives.

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First transition: From a fair to a criminal privatisation model The main objective of the first transition in Croatia was the changeover from a socialist to a capitalist system of production, management and ownership to raise the entire system to a higher level of efficiency, with private ownership being considered the main generator for the stated objectives. But the privatisation model became distorted, and the relatively fair initial model was appropriated and transformed by interest groups and aligned to their objectives. At the outset, employees and former employees were able to purchase up to 50% of companies at a discount of up to a face value of 20,000 marks. It was anticipated that the shares would be repayable in five year instalments, from the date of signing the contract. If payments were not made in time, the shareholders would be entitled to dividends only on the shares that they had actually paid for in full. Another way of ownership conversion provided for the transference of two-thirds of the value of the company to the Croatian Development Fund and one third to the Retirement and Disability Fund. This model gave employees and former employees priority in the purchase of stocks. The funds could assign the right to manage the company to a domestic or foreign entity. In 1992, the Parliament passed the Law on the Croatian Privatisation Fund, which entered into force in May 1993. Under strong pressure from lobbies, future tycoons and some politicians, in October 1993, an amendment of the Law on the Transformation of Publicly Owned Enterprises was adopted. According to that amendment, it was possible to transfer subscribed shares bought in instalment payments by employees to another person. Those who acquired the shares had to take over the responsibility of paying the instalments to the Croatian Privatisation Fund and assumed all rights and obligations. This amendment to the law was important because it enabled employees to be persuaded to forego their ownership rights for far less money than they had expected, with the shares being sold below the market value. Those who bought the shares were privatisation vultures, because they bought shares for a fraction of their worth. In January 1994, the Law on the Transformation of Publicly Owned Enterprises was amended again. The newly adopted amendment was unsound in that it diverged from the initial model and created the basis for possible criminal activity.

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The State Audit Report informed Parliament that from April 2004 to 2008, the Supervisory Board of the Croatian Privatisation Fund met only once. From January 2008 to July 2010, there was no Supervisory Board. This means that all the presidents of the Croatian Privatisation Fund worked without their actions being approved by the Supervisory Board. During this entire period, the Fund was actually under the direct control of the government and the influence of lobby groups. The simple conversion of public into private enterprises in order to determine the ownership, without prior restructuring having taken place, has not solved the structural problems of the Croatian economy.

The peddler model of privatisation The sale of shares that were not fully paid was not initially planned. The Law was not explicit in this, but it was evident from the second amendment of the Law, which did prescribe that shares could be sold even if they were not paid in full. The Law was amended, so that the shareholder could get a dividend even if the stock was not paid off in full. This created a disorderly situation in which “peddlers” came and bought a block of shares, for example for one hundred marks, and received dividends even though the shares were not fully paid.

2005

2004

2003

2001

2000

Registered unemployment rate

2010

2009

2008

2007

2006

ILO unemployment rate

2011

1999

1998

1997

1996

2013

2012

161

Source: CBS.

Note: Since the beginning of 2007 results from the Labour Force Survey have been published in quarterly dynamics. ILO unemployment rate refers to persons aged 15 years and over.

* Registered unemployment rate for January–June 2014; ILO unemployment rate for first quarter of 2014.

0

5

10

15

20

25

2002

Figure 8-4. Unemployment rate 1996-2014 (in %)

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2014*

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Parasitic capitalism The problem was not just that peddlers took over a company, but rather that the majority of these peddlers were not really entrepreneurs. They just took over “cheap” property and resold it at higher prices. This created a model of rentier (parasitic) instead of entrepreneurial capitalism. When small shareholders saw that companies were being taken over by a small group of individuals and that they as shareholders did not have a significant role, they sold their shares for a fraction of their worth. After that, the private owners directed all the proceeds from privatised companies to newly established subsidiaries. Consequently, it appeared that the privatised companies were not profitable. In this way the privatised companies ended up bankrupt and their employees were left jobless. Table 8-2: Some results of privatisation Changes in the private sector 2,553 new joint stock companies

Significant changes in BDP structure Agriculture (dropped from 11 to 4.4% of GDP in 2014)

Total equity - 10 billion USD

Industry (from 36 to 31% of GDP in 2007 and subsequently to 22% of GDP in 2014)

Number of shareholders - 667,483

Services (increased from 53 to 62% of GDP)

Forms of Payment: in kuna (HRK) 14.3% , in a strong currency 11.0% , bonds 4.5%, “frozen deposits" 70.7%

The share of private sector in GDP - 65%

The largest part of the total work force is employed in SMEs Sources: CNB, CBS, Croatian privatisation fund

Privatisation has not contributed as promised to the growth of productivity, modernization of production, income or employment. It destroyed assets that had been built up over generations. Accordingly, some Croatian economists engaged in research into privatisation and transformation have called this an “epochal crime” or “the sin of the structures”, committed against the Croatian state, the Croatian economy

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and all the citizens. It has created unemployment, poverty and a large internal and external debt. Succinctly; the destruction of many healthy companies, a loss of markets, a fall in competitiveness, the creation of an army of unemployed (700,000 people had lost their jobs by 1999 alone). What happened was exactly what should have been avoided.

Privatisation of Croatian banks When independence was achieved, Croatian banks were for many reasons unable to disburse foreign currency deposits. Then the Government intervened, converting “old foreign currency savings” into public debt, which was covered by the issue of bonds in the amount of 4 billion USD. The state conducted the recovery of five banks in 1996. According to the CNB analysis, it was calculated that the total fixed cost of bank recovery in Croatia from 1991 to 1998 reached 31% of yearly GDP. Other states had banking crises as well. In France, the cost of the bailout reached 10% of GDP, in Hungary 12% of GDP and in Spain 15% of GDP. Croatia could be compared to Chile which paid 33% of GDP for the recovery of its banks. Before the privatisation of the banks, foreign investors demanded that the Government should first rehabilitate the banks, which was done. The state issued “big bonds” that no one bought. They were simply awarded to foreign investors and created a huge liability for the state budget. The rehabilitation and bank bailouts created a total cost to the taxpayers of about 12 billion USD. At the same time, earnings from the sale of the banks were around 1 billion USD. Croatian citizens are still not sufficiently aware of the destructive manner in which bank privatisation was carried out. The structure of the Croatian economy through the period changed significantly with a very sharp decline in the share of industry in GDP, while the share of services was increased.

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Financial and insurance activites 7%

Source: CBS.

* The data refer to first quarter

Real estate 12%

Professional service activities 8%

Public administration and defence 17%

Other service activities 3%

Trade, hotels and restaurants 17%

Construction 5%

Industry 22%

Information and communication 5%

Agriculture 4%

Figure 8-5. Gross value added structure in 2014* in current prices

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Along with a badly-judged model of enterprise privatisation, a poor exchange rate policy was an additional important source of economic problems. At the time of the breakup of Yugoslavia, Croatia had one of the strongest industrial sectors in Southeast Europe. Today, industrial production is 80% of the pre-war level. The growth in the foreign trade deficit was offset by growth in revenues from tourism. Tourism has been declared the most important sector of the economy. The deindustrialization process that began in 1993 is still under way. The economic development programs that were adopted on several occasions throughout the observed period by various governments, i.e. the two most important political parties, were not consistent. Such development programs were not even achievable because the process of liberalization of capital movements, privatisation and institutional weakness took the Croatian economy in an entirely different direction. The growth model was based on consumption as predominantly funded by foreign borrowing, privatised banks serving as a platform for the credit boom and excessive spending.

Second transition: premature and unprepared accession to the EU The anti-inflation program of 1993, aimed at lowering inflation in the short term, was successful. For this purpose, the exchange rate of the kuna (HRC) was firmly pegged to the mark and later to the euro in order to prevent negative expectations. Yet, instead of the stabilization program being applied only until the end of 1994, it has remained a base for the economic policies of all governments. The foreign exchange rate has essentially been fixed until today. It is completely unrealistic and has accordingly, enabled the growth of imports, weakening the competitiveness of Croatian companies and producing a continuous trade balance deficit and external debt growth. In the first transition period, Croatia failed to prepare properly for the second transition, that of accession to the European Union.

75

80

85

90

95

100

Q3/11

Q1/11

Q3/09

Q1/09

Q3/08

Q1/08

Q3/07

Q1/07

Q3/06

Q1/06

Q3/05

Real, producer prices - right

Q1/12

Real, unit labour costs in total economy - left

Q3/12

Real, consumer prices - left

Q1/13

Nominal - left

Q1/14

Q3/13

Q1/05

75

80

85

90

95

100

105

Source: CNB.

Note: The real effective exchange rate of the kuna deflated by producer prices is based on the Croatian index of industrial producer prices on the non-domestic market, which is available from January 2010. In 2014, the CNB revised the effective exchange rates of the kuna by extending the basket of the main trading partner countries and applying time-varying weights. The fall of the index denotes the appreciation of the kuna.

Index, 2001=100

105

Q1/10

Figure 8-6: Index of nominal and real effective HRC exchange rates

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Q3/10

166

Index, 2010=100

167

Czech R.

Hungary

Sources: Eurostat and CNB.

-2

-1

0

1

2

3

4

5

6

Poland

Slovak R.

Slovenia

Figure 8-7: Current account balance by countries in 2013 (% of GDP)

Bulgaria

Romania

Croatia

In the first transition period, Croatia failed to prepare properly for the second transition, that of accession to the European Union.

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2005

2004

2003

2002

2001 Current account deficit

2007 FDI

2011

2010

2009

2008

2000

1999

1998

1997

1996

1995

Note: FDI inflows to Croatia and current account balance exclude Pliva's transfer of patent rights to the affiliated company abroad in 2003. Source: CNB

-2

0

2

4

6

8

10

12

2006

Figure 8-8: Current account deficit and FDI inflows in Croatia (in % of GDP)

2012

Rapid liberalization of capital flows and foreign trade did not enable domestic enterprises to adapt and prepare for strong competition on the EU market. Therefore, Croatia has had a continuous and large trade deficit with the EU member states. In addition, Croatia has a high foreign debt, which is becoming an increasing threat.

168

2013

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In this period, the high expectations of foreign direct investment (FDI) were explicit. Policy makers and the public believed that foreign investors would be predominantly interested in new productive investments. Instead of production and new investments, however, foreign investors preferred the purchase of existing high-quality companies, primarily from the services sector. Unlike some other countries of Central and Southeast Europe, Croatia has failed to attract high-quality FDI, in terms of both scope and structure. Over 70% of imports and exports were enacted with developed countries. The technological transformation of companies was slow due to insufficient investment in production, education and science. The greatest technological progress was evident in the telecommunications sector. These problems were accompanied with an excessive tax burden and the continued inefficiency of state institutions. From 1993 to 2014, foreign investors invested over 27 billion EUR in Croatia. About 60% of all foreign investment refers to the four most profitable sectors: financial intermediation, telecommunications, pharmaceuticals and trade-brownfield investments. Greenfield investments were of marginal importance. After selling the most profitable companies to foreign investors, the government has had to continue to care for the sick companies. These “zombie companies” represent an additional burden on the already weakened state budget and impose tremendous fiscal risks due to government guarantees issued for their borrowings and other potential liabilities. Foreign takeovers of domestic firms have not positively affected the restructuring of the economy or growth in exports.

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Source: CNB

* Preliminary data

Manufacture of coke, refined petroleum products 6%

Manufacture of chemicals and chemical products 5%

Retail trade 5%

Real estate investments 3%

Other business activities 6%

Manufacture of other non-metallic mineral products 3%

Other activities 17%

Real estate activities 8%

Wholesale trade and commission trade 10%

Financial intermediation, except insurance and pension funds 31%

Post and telecommunications 6%

Figure 8-9. Foreign direct investments in Croatia: 1993-Q1/2014* (27,224.1 million EUR)

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Nominal and real convergence with the EU Before accession to the EU, Croatia met all the nominal Maastricht criteria: the state budget deficit was below 3%, public debt was below 60% of GDP and the inflation rate was around 3%. Only the interest rates were higher than those prescribed by the criteria. However, real convergence has been slow and can be particularly seen in the areas of technology, productivity, organisation and management, attitude towards work and the large share of government in GDP. The expectations of people regarding EU accession were to a large degree, wrongly formed, whereas policymakers and politicians did not try hard enough to properly present this concept with all its good, but also bad consequences. They strongly promoted only positive expectations. It was felt that joining the EU was in itself, enough for the small Croatian economy, within a reasonable time, to be able to profit from being in the society of large, wealthy countries like Germany, France, Italy and so on. In such an environment, the attainment of real convergence was absent, and the expectations were that the process would be performed by powerful companies in the EU, that would show an interest in mergers and acquisitions in Croatia. On the other hand, workers and the unemployed expected that the EU accession would facilitate the free movement of labour according to the optimum currency area theory, which did not happen. Thus, no real convergence has been achieved, the free movement of workers has been disabled and Croatia has found itself in a very disadvantageous position; a long-term recession, or rather, depression that has lasted since 2009.i

Conclusion Croatia went through the first economic transition unsuccessfully and with significant negative consequences. The economy ended up literally destroyed and predatory capitalism has sent bad moral messages to the younger generations. Since Croatia had not adequately coped with the consequences and needed more time to recover from the systematic destruction of the economy, accession to the European Union proved to be hasty and imprudent. Croatia joined the EU unprepared and, therefore, the second transition to the EU relied only on the nominal convergence criteria. Croatian companies are too small and weak to compete with powerful multinational corporations in the EU. Multinational corporations from EU do not take a significant part in stimulating the growth of

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Croatian GDP, as they do for example in Denmark and Belgium. Migration of the Croatian work force is still restricted in most EU countries. The interest rate is high and the exchange rate overvalued. These two important instruments are not being used for correction of internal and external imbalances. The concept of internal devaluation will not produce positive results. Croatia has not succeeded in the first transition, and in the second, it still has to pass a tortuous path with uncertain consequences. The Croatian economy needs a new ethic and a new economic policy model with an accent on growth and not just price stability, higher foreign investments and penetration of former markets.

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Meštroviü (ed.), Globalizacija i njene refleksije u Hrvatskoj. Zagreb: Ekonomski institut, 133-148. Vehovec, M. (2002). Evolucijsko-institucionalni pristup razvoju poduzetništva. In: D. ýengiü, M. Vehovec (ed.), Poduzetništvo, institucije i sociokulturni kapital. Zagreb: Institut društvenih znanosti Ivo Pilar. Vining, A. & Boardman, A. (1992). Ownership Versus Competition: Efficiency in Public Enterprise. Public Choice, 73, 205-239. World Bank (1996). From Plan to Market – World Development Report. The World Bank.

Notes i

The main macroeconomic indicators are presented in the Appendix (Figures A1, A2, A3 and A4).

-5

0

5

10

15

20

25

30

35

40

2002

2001

2000

Real growth rate – left

2003

1997

1996

1995

1994

* Data for January - June 2014. Sources: CBS and CNB

%

45

1998

Figure A1. Nominal and real net wages

1999

Appendix

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2011

2010

2009

2008

2007

Nominal net wage – right

2006

2005

2004

176

0

100

200

300

400

500

600

700

800

EUR 2014*

2013

2012

1998

1997

1996

2004

2003

2002 CPI inflation

2008

Core inflation

2011

2010

2009

2005

2001

2000

1999

Source: CBS

Note: CPI inflation (1996-1998 RPI inflation) and core inflation, average year-on-year rate of change

* January – June 2014.

-1

0

1

2

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5

6

7

2006

Figure A2. CPI and core inflation, EOP, year-on-year rate of change (in %)

2007

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2014*

2013

2012

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External debt service/Exports of G&S

External debt/GDP

External debt/Exports of goods and services

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: CNB.

0

50

100

150

200

250

300

Figure A3. External debt ratios (in %)

178

Hungary

Poland

Slovak R.

Outstanding external debt/Exports of G&S

Czech R.

Sources: Eurostat, CNB and central banks’ websites.

0

50

100

150

200

250

Figure A4. External debt ratios by countries in 2012 (in %)

Bulgaria

Romania

Outstanding external debt/GDP

Slovenia

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Croatia

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CHAPTER NINE THE ROLE OF REGIONAL DEVELOPMENT AGENCIES IN REDUCING REGIONAL DEVELOPMENT DISPARITIES: THE CASE OF IZMIR DEVELOPMENT AGENCY ERGÜDER CAN

Abstract: This chapter analyses the changes in the new development approaches and the “development agency” tool in Turkey following the accession period to the European Union (EU). Turkey has started a transition in public administration and this transition basically involves a shift from central oriented regional development policies to locally-oriented plans, policies, and practices. Among the basic functioning tools in this decentralization process are regional development agencies. Regional development agencies have started to work in 2006 to reduce regional disparities and the Izmir Development Agency (IZKA) is the first agency in Turkey. This chapter aims to explain the potential benefits of regional development agencies in overcoming the vast regional disparities that remain and how they can be utilised for better governance envisaging. Regional development agencies play key roles in encouraging regional economic development and creating new jobs. Keywords: Regional development agencies, regional disparities, economic development, Izmir Development Agency

Introduction Regional development disparities have been one of the major problems in many countries. Many policies and tools have been developed and implemented in regions to decrease development disparities and to achieve regional development goals. The development tools and policies have been

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differentiated alongside the changes in the regional development concept. Various institutional, economic, social and cultural tools were used to develop the regions. Unlike the policy in the 1950s and 1960s, which was to decrease regional disparities through government initiatives, today’s regional development objectives are based on gaining global competitiveness and developing all regions (Batchler, 1999). Stimulating the local endogenous dynamics is key to achieving these objectives instead of using redistribution mechanisms. Actually, the number of actors now involved in regional development issues has increased. Along with the central government, supranational and local actors now play a role in the development of regions. Previous top-down regional development policies have been changed to bottom-up policies. In today’s world, regional and local development is achieved through governance and policy networks in which those actors actively participate. Therefore, the role and efficiency of the flexible intermediary organisations have become more and more important in achieving regional development. Some of these organisations that maintain endogenous development of regions are the regional development agencies (RDAs) that exist in many European countries since the 1950s (Halkier et al. 1998). Like many other developing countries, Turkey still has huge regional development disparities. Although many tools have been implemented, none could prevent the development inequalities between the west and the east, or between urban and rural areas. Since the beginning of the 1990s, due to the effect of the EU preaccession process and the novel forms of territorial governance, the direction of change in regional development tools has become evident. In Turkey, civil initiative participation has led to an increase in the number of actors that take part in development. The aim of this chapter is to analyse the benefits and contributions of the newly established agencies in Turkey in regards to regional development. The chapter first discusses Turkey’s regional policy and development tools. Subsequently, it explicates the Izmir Development Agency, and evaluates interview and survey results that were conducted with the leading development actors in Izmir and IZKA staff, in order to emphasise the difference they may create in the region’s development.

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The Role of Regional Development Agencies in Reducing Regional Development Disparities Development agencies (DAs) are organisations that aim to achieve and support economic, social and cultural development and endogenous development of a certain geographic area. According to Halkier et al. (1998) DAs are organisations outside the mainstream of central and local government that stimulate regional economic development with public funds. The first DA was established in the USA in the 1930s. After the Second World War, to decrease the effects of war, many European countries began to establish DAs. Generally DAs nourish a region’s economy in cooperation with other local actors. Recently, the EU has supported their establishment in member states, especially in the new member states, for the implementation of EU regional policy because of their flexible and dynamic structures (Danson et al., 2000). Objectives of the DAs include improvement of cooperation among the public sector, private sector and NGOs; ensuring effective usage of resources; stimulating the local potential; fostering regional development and ensuring its sustainability; and decreasing inter-regional development disparities. Within the scope of these objectives, RDAs have three main functions to reduce regional and inter-regional disparities. First, producing and implementing regional development plans and strategies with participatory techniques to set the direction of development in the region. DAs’ main approach is to produce these strategies with a bottom-up approach. The second main function is to promote investment opportunities and support investors in every stage of investment in order to attract more foreign and domestic investments in the region. Third, financial support mechanisms enable all the actors in the region to take part in the regional development process. RDAs especially support Small and Medium Enterprises (SMEs) and award grants to successful projects. This mechanism increases the capacity of SMEs and creates new jobs.

Regional Policies of Turkey and Development Agencies Regional Policy The traditional approach to regional development in Turkey is based on redistribution mechanisms for economic growth and the creation of employment. Dependence on external resources and the “exogenous

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growth” approach has been behind traditional regional policy in Turkey for many years. However, this redistribution logic has not achieved its aim and Turkey still has economic disparities among its regions. In other words, the disparities in socio-economic structures and income levels across regions remain significant. An integrated regional development policy, which includes different measures tailored according to the problems and potentials of the various regions, is still needed (DPT, 2006). The period from 1923 to 1950 can be named as the unplanned regional development period in Turkey, while the next decade was the period of the agglomeration of private sector investments in Istanbul and the Marmara region (DPT, 2000). Since the 1960s, Turkey has attempted to achieve social, economic and cultural development through five-year development plans. The implementation of the first five-year development plan was initiated in 1963 and the latest plan, the ninth five-year development plan, covers the period of 2007 to 2013. In this plan, the regional policy was based on local dynamics, with internal potential differentiated for relatively underdeveloped regions and centers, with high development potential and plans to equip them with innovative, multi-dimensional and diversified instruments (DPT, 2006). Until the EU candidacy process, there are three major economic development tools aimed at eliminating regional disparities in Turkey: (i) policies and incentives toward the public sector, (ii) incentives to enhance the private sector and (iii) regional and rural development projects. Three different groups of regions are defined to ensure more efficient implementation of these incentives: (i) developed regions, (ii) priority regions for development and (iii) normal regions (ABGS, 2000). Since the 1960s, the State Planning Organisation (SPO) has had the duties of making and implementing regional plans and development plans (DPT, 2000). The Directorate General for Regional Development and Structural Adjustment of the Ministry of Development is directly involved in regional policy issues within the central administration. Another institution, the Regional Development Institute of Small and Medium Sized Industry Development Organisation (KOSGEB) was established in 1998 to encourage the creation of Small and Medium-sized Enterprises and investors in order to ensure regional development. Other institutions involved in regional policy issues are the Ministry of Industry and Trade, the Ministry of Public Works and Settlement, and the Ministry of Agriculture and Rural Affairs. The Ministry of Environment and Forestry is responsible for territorial planning at the 1/25,000 scale, which is the

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sub-scale of the regional plans in Turkey. The local administrations have three levels—provinces, districts and villages. The administrations are special provincial administrations and municipalities. In provinces and districts, local governors are appointed by the central government; however, the chairmen of municipalities and municipal councils are voted in through local elections for five-year periods. Local councils and chairmen are responsible for physical planning, infrastructure and, to some extent, economic and social development, in collaboration with the agents of central departments operating under the provincial governor. The EU accession process of Turkey has caused radical changes in regional development policies. The necessary infrastructure is being created at the central and local levels in order to prepare for the structural funds that could be used after membership. Second, the official Nomenclature of Units for Territorial Statistics (NUTS) was defined at three levels in 2002. NUTS helps formulate the determination of the framework for regional development policies, the collection of regional statistics and the creation of a statistical database compatible with the EU regional statistics system. New incentive measures for accelerating growth in investments and employment, and increasing the contributions of the private sector to regional development were put into practice. Discounts were implemented for income tax and the Social Insurance Institution (SSK) premium payments imposed on employees in enterprises located in provinces covered within the scope of regions prioritised in development (RPDi). In addition, energy cost support and land without charge was introduced to these enterprises. Support also continues for various projects of Special Provincial Administrations and municipalities in RPDs from appropriations of the local administrations. Implementation of the Southeastern Anatolia Regional Development Project (DAKAP), the Zonguldak-Bartn-Karabük Regional Development Project (ZBK), the Eastern Black Sea Regional Development Plan (DOKAP) and the Eastern Anatolia Project Master Plan (DAP), which were prepared during the past periods, and the activities for the Yeúilrmak Basin Development Project (YHGP) are continuing. However, excluding the South East Anatolia Project (GAP), these projects were provided with limited financing opportunities only within the scope of sectoral allocations.

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The Izmir Development Agency (IZKA) prepared the 2010-2013 Izmir Regional Plan, which was approved by the State Planning Organisation (SPO, changed in June 2011 to the Ministry of Development) in June 2010. This is the first plan prepared by a DA in Turkey. The authority and responsibility of local administrations in the field of development were increased with the Laws on Special Provincial Administrations, Municipalities, Metropolitan Municipalities, and Local Administration Unions. One of the most radical and important steps in Turkey’s regional development policy is the legislation of the establishment of RDAs and the establishment of two pioneer RDAs in Izmir and Cukurova (Mersin and Adana) regions.

Development Agencies In Turkey, there were no DAs until 2006 (Can, Kocagül, 2008). In fact, beyond the SPO, only the GAP administration had taken part in regional development planning and programming. Moreover, both of them work at the central level. Therefore, there has been a need for the management of regional development polices at the local level for many years. The will to establish the DAs has been previously included in the National Development Plan and various regional development plans; especially after the 1990s and 2000s DPTs, the Development Bank of Turkey and the chambers of Commerce and Industry have promoted some central and local initiatives to establish DAs in Turkey. The main factor that accelerated the process for the establishment of DAs is that Turkey had gone through institutional and legal regulations to achieve harmonization with the EU’s regional policies. During the EU accession process for the management of structural funds, DAs have been envisaged as the necessary tools for Central and Eastern European Countries. With the issuing of Law, No. 5449, DAs are planned to be established in 26 NUTS 2 regions. In this regard, DAs would be the strategic and operational organisations supported by the central government. “The Law on the Establishment, Coordination and Duties of Development Agencies” aims to institute cooperation between the public and private sectors, and civil society organisations in order to mobilize local resources and to institutionalize a regional development mentality. For achieving this aim, the general activities of DAs are:

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-

-

-

-

-

to provide technical support to the planning studies of local authorities; to support activities and projects ensuring the implementation of the regional plans and programs; to contribute to the improvement of the capacity of the region concerning rural and local development in accordance with the regional plans and programs and to support the projects within this context; to improve cooperation between the public and private sectors, and non-governmental organisations to achieve regional development objectives; to carry out research studies, or to have them carried out, concerning the determination of resources and opportunities of the region, the acceleration of economic and social development, and enhancement of competitiveness, and to support other research carried out by other individuals, organisations and institutions; to promote business and investment facilities of the region at the national and international levels, with close cooperation with other related institutions; and to support SMEs and new entrepreneurs in fields such as management, production, promotion, marketing, technology, financing, organisation and labour force training, by ensuring cooperation with other related institutions (Law No. 5449, 2006).

In these respects, the activities of Turkish DAs have some similarities with DAs in European countries (Pala, 2005). The DAs most powerful tool for regional development will be a grant scheme managed by them. The funds for these grant schemes and the budget of the DAs are based on both central and local funding. The budget composition of DAs is as follows: x Appropriations to be determined by the High Planning Council according to the population, development level and performance measures of each Agency from the residual fund—after the shares transferred to local administrations and funds by tax refunds are deducted from the general budget and tax revenue of the previous year—and from the transfer allowance to be allocated (five per thousand each year), from the European Union and other international funds, and activity revenues. x Over the budget revenues of the previous year, appropriations to be transferred from the current year, budget at the rate of 1% for special provincial administrations, excluding falling into debt, allocated revenues, and aid items received from organisations

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having general, additional, and private budgets; for municipalities, appropriations to be transferred from current year, budget at the rate of 0.5 % excluding falling into debt and allocated revenue items; and appropriations transferred from the current year, budget at the rate of 1% of the previous year’s final budget for revenues of the Chambers of Industry and Commerce in the region. x Aids and grants provided by national and international institutions, and organisations; revenues turning over from the previous year (Law No. 5449, 2006). The RDA structures in the draft law carefully avoid disrupting Turkey’s traditional center-local public administration structure. RDAs are not planned to constitute a separate layer of dedicated regional structures for regional development purposes. Instead, their decision-making organ is composed of representatives of local administrations (provincial governors and mayors) and the local private sector (Chambers of Commerce and Industry in each province). There are four main components in the organisational structure of DAs. The first one is the Development Board (DB). The law tries to improve partnership between the public and private sectors, and civil society through the DB, which has an advisory role. It is composed of representatives from the public and private sectors, civil society organisations, universities and local administrations, and meets at least twice a year. The members of the DB are selected by the permanent members of the executive board, as stated in the Law. The composition of the DB changes depending on the institutional and organisational structures, and the capacity of the regions. The second main structure is the executive board. The chairman of the executive board is the governor of one the provinces in those NUTS 2 regions that consist of more than one province. Annually, the position shifts to the governor of one of the other provinces. In NUTS 2 metropolitan regions, Istanbul, Ankara, and Izmir, the decision-making organ or the executive council of the RDA is composed of the governor, the metropolitan mayor, the president of the Council of the Special Provincial Administration, the president of the Chamber of Industry and the president of the Chamber of Commerce, as well as three representatives of the private sector and/or civil society elected by the DB.

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The Secretariat General is responsible for the execution of activities. The Secretary General is the superior Chief of the Secretariat General and investment support offices, and is responsible to the executive board. The Investment Support Office, which is a part of the Secretariat, is mainly designed to be a one-stop shop for investors. For each province, a Support Office will be established. The working principles of the DAs are defined in regulations whereas the organisational structure is flexible and can change from one agency to another. It is, however, explicitly stated in the law that DAs are under the coordination of the SPO (art. 4: Law No 5449). Furthermore, the SPO allocation of most of the budget of DAs indicates an organic relationship between a central organisation and the DAs. Also, the SPO reviews the annual working plans, and approves and controls the budgets of DAs (art.25: Law No 5449). Therefore, DAs are not totally independent, as criticized; instead, they are under the coordination and control of the SPO and other ministries regarding their particular activities. As mentioned before, the Izmir (IZKA) and Cukurova (CKA) DAs were established in 2006. Eight RDAs were established in 2008 and 16 RDAs were established in 2009. The process of establishing IZKA as the forerunner agency began in July 2006 and ended in December 2006 with the recruitment of its personnel.

Izmir Development Agency (IZKA) Izmir is Turkey's third largest city, after Istanbul and Ankara, and its second most important port. It is located on the west coast of the country and possesses a large hinterland known as the Aegean Region. The designation of Izmir as a pilot region for starting DAs in Turkey aroused substantial criticism. However, it is possible to deem that it was a logical decision to begin the new system in Izmir, where the institutional capacity was organised and prepared for activating governance. Moreover, in spite of Izmir’s third place in the socio-economic development index of Turkey, there are development disparities within the region.

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Figure 9-1.: Districts’ socio-economic development indices (SPO-2004) 5

4

3

2

1

Ki ra z

K n k

Ö de m iú

Ti re

D ik ili

Se lç Ka uk ra bu ru n

-1

U Se rla fe rih is ar

Al ia ÷a

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The corporate identity of IZKA was prepared, and the organisational structure of IZKA was determined after 3 months. A functional organisational structure was accepted that matched better with the grant scheme mechanisms. The departments, as shown in Figure 9-2, are: Planning, Programming and Coordination, Program Implementation, Monitoring and Evaluation, Investment Support Office and Administrative Office. IZKA presented itself to the public at the beginning. IZKA utilised the time period between its establishment and its suspension to raise awareness about the activities of IZKA in Izmir; to collect data about the economic, social, cultural structures of Izmir; to conduct research on different strategic and potential sectors for Izmir; and to prepare for the grant scheme mechanisms. Establishing cooperation with local actors was a priority for IZKA (Can, 2011). A survey was conducted with three different groups in order to understand what IZKA could do for øzmir’s development and how it was perceived in the region as a new development organisation. These groups were the executive board members, DB members and the staff of IZKA.

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The survey inquired about the activities and roles of IZKA in Izmir’s development, the organisation’s structure, its cooperation with other actors and what needed to be changed in the DA law (Law No. 5449). Figure 9-2.: Organisational Structure of IZKA

The executive board members expressed their ideas as mainly in favor of the system in the trial phase. They all considered the Izmir Development Agency as an urgent necessity for many actions that needed to be taken in order to accomplish the Izmir development vision, which was briefly stated as: “An innovative, sustainable and competitive global city with high quality of life standards.”

Most of the executive board members mentioned that IZKA was important at the local level for coordinating economic development activities. They stated that coordinating the formulation of a common vision, goals and strategies for the development of the region should be the main mission of IZKA. According to the president of the executive board of the Aegean Chamber of Industry, this could also prevent the duplication of the activities for economic development that were being planned by different organisations. The Governor of Izmir emphasised that all of the functions defined in the DA law were satisfactory enough. However, according to other board members, different activities among these functions should be prioritised. For example, one of the important issues mentioned by the president of the executive board of the Izmir Chamber of Commerce was attracting foreign

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direct investment by IZKA. Green field investments would give Izmir the capital and know-how to compete in global markets. Another function that he identified as fundamental was services provided for SMEs. The DB members mostly redefined the Agency’s role in a more active way. The district representatives of IZKA DB emphasised the agency’s role of reducing economic development disparities between the districts of Izmir. The commentators based their remarks mostly in their areas of expertise. For instance, an environmentalist engineer indicated the importance of the environment in development, while social indications of development were stressed by other members of the DB. As a matter of fact, members of DB kept their expectations of the Agency high; the majority wanted the Agency to begin operating again as soon as possible. In the current working regulations, the functions of DB are not clear. Only the detailed meeting rules have been defined (art 4-art 15)ii; however, the utilisation of the members’ expertise is vague, so the participation needed to fulfil the full “advisory” role of the DB is missing. According to the president of the executive board of the Agean Economic Development Foundation (EGEV), the regulations were not prepared diligently but in a rushed way. He believes that the current articles in regulations are in some ways incompatible with other regulations. The role of the DB has been defined as a participatory and consensusbuilding platform by the commentators. Sometimes the lack of inner directives misleads the functions of the DB. Executive board members state that DB has the important role of “guiding” the executive board but neither making, nor approving decisions on the activities of IZKA. On the contrary, some DB members find the guiding role to be “ineffective” and “time-consuming” because they all have substantial roles in the community (Can, 2011). In spite of the problems encountered in the roles and functions of the DB, it is the fundamental structure in DAs for legitimizing and performing their roles as catalyst organisations. The democratic and participatory environment of the DB, which includes different representatives from different local organisations, could make Izmir think outside the box, appreciate different thoughts and achieve common goals for development. The organisational structure of the executive board is another debate. Some envision DAs as an extension of the central government as long as a governor is leading the executive board; while others believe it is logical for the governor, as the highest authority figure in the management of the region, to serve as the leader of the executive board.

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IZKA’s executive board members have found the temporary suspension period useful as it renders a chance to re-evaluate the DA’s functions and could be turned into an opportunity for the SPO to review its weaknesses. In subjects requiring in-depth knowledge and participation, some definitive roles for the DB can be defined in the law. For instance, the extent of those issues should include the vision and strategies for the region. The definition of responsibilities in accordance with the activities is expected to be more clearly defined by the lawmakers. Most of the DA's working staff stated that the activities of the agencies were vague and too broadly defined. In fact, this broadness has a positive and negative side. The broad activities defined in the law let the agencies conduct specific activities tailored to their regions. However, some of the activities, like regional planning preparation, should be clarified. When we look at the main function of DAs, it is to make regional development plans and strategies for their regions. However, in Turkey the law defines their roles as only monitoring and supporting the preparation of these plans and strategies. The Ministry of Development is the only responsible organisation for the preparation of regional plans in Turkey, although it also has the power to have plans prepared by other organisations. The Ministry of Development gave the DAs the role of preparing regional plans; but there is a lack of laws for the implementation of plans. After DAs have prepared plans, the Ministry can approve them. But there is no regulation if the local authorities disregard the plans. Regarding the organisational structure of the DA, it is certain that the DB is one of the important organs that enable their legitimization and raise awareness among local actors. However, most of the staff stated that DB membership should be voluntary. Most of the DB members are unaware of their responsibilities in the DB, and many staff members stated that training of DB members about the DA and its activities is necessary. The most important role of the DAs, according to the staff, executive board members and DB members, is to foster collaboration and cooperation among local actors for the development of the region. Most of the respondents, however, stated that the legal status of the agency sometimes hinders this cooperation. For this aim, the first actions of the agency should be promotional activities. Staff members believe that if the legitimization of the agency in the region and among other local actors’ increases, the collaboration and cooperation capacities will also increase.

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Another important element for facilitating cooperation, according to the people, is being knowledgeable about the activities of other organisations involved in regional development.

Conclusion Turkey has experienced regional development differences for many years. Incentives have been given for lagging regions and regional development plans have been prepared to overcome this problem. These regional policy approaches have recently begun to change in Turkey. In the last two National Development Plans, the classic regional policy approach of Turkey has been changed. The focus of policy has shifted from the underdeveloped regions to all regions. The main approaches have become to stimulate endogenous development dynamics and to develop different regions with various development tools. The first step to achieving this is using the tools of Turkey’s new regional policy, which has increased institutional capacities at both local and regional levels. Moreover, it is a commonly agreed fact that Turkey is supposed to activate decentralization in order to become a part of the EU and to compete in the fierce economic conditions of today’s highly globalized world. The idea of the establishment of DAs is related to the new regional policy and to the adaptation of the EU’s regional policies in Turkey. Many challenging situations within the current law, including the preparation and implementation of regional plans, will hopefully be revised in a short time period. Currently, 26 DAs are operating to develop their respective regions and they will play an important role in Turkey. For many years, Izmir has been the innovator in many fields. For regional development it also has the capacity to initiate a bottom-up approach. IZKA is an advantage for all the local actors who have been longing for such a structure since the 1990s, suggesting that IZKA would succeed, if the legal situation permits, in spite of a top-down structure that would inevitably fail. The past exhibits that no single organisation has the power to stimulate the economic development of regions single-handedly. In today’s globalized and highly competitive world, the main activity of IZKA should be to encourage collaboration, cooperation and partnerships among actors. IZKA should get support from all regional actors and continue its activities. Development Agencies are the tools to start a new development era in Turkey, and the success of IZKA and Izmir, as the forerunner in the new era, is fundamental.

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References ABGS. (2000). Avrupa Birli÷i Müktesebatnn Üstlenilmesine iliúkin Türkiye Ulusal Program, www.abgsgov.tr Bachtler J. (1990). Regional Policy in the 1990s. In R. T. Harrison & M. Hart (eds.), The European Perspective, in Spatial Policy in A Divided Nation (pp. 254-269). UK: Jessica Kingsley Publishing. Can, Ergüder (2011) Bölgesel Kalknmada Kalknma Ajanslarnn Rolü: øzmir Kalknma Ajans Örne÷i, Altn Nokta Yaynevi, øzmir. Can, Ergüder & Akdeniz Kocagül Dilek (2008), Avrupa Birli÷i'nde Bölgesel Politikann Geliúimi ve Yapsal Fonlar, TEPAV Yayn, Ankara. Danson M., Halkier H. V. & Cameron G. (2000). Governance, Institutional Change and Regional Development. UK: Asgate Publishing. Danson M. & Cameron G. (2000). The European Partnership Model and the Changing Role of Regional Development Agencies: A Regional Development and Organisation Perspective, in Governance, Institutional Change and Regional Development, pg.11-36, M. Danson, H. Halkier, G.Cameron (eds.), Asgate Publishing, UK. DPT (Devlet Planlama Teúkilat - State Planning Organisation), www.dpt.gov.tr —. 2007, IX. Kalknma Plan (2007-2013), www.dpt.gov.tr EBKA, 1993, Haber Bülteni No.1, EGEV, øzmir. EGEV, 1993, EBKA presentation document, EGEV, Izmir. —. 2007, EGEV Dosyas Raporu. Halkier H. & Danson M. (1998). Regional Development Agencies in Western Europe. A Survey of Key Characteristics and Trends, in Regional Development Agencies in Europe, pg. 26-44, H. Halkier M. Danson ve C. Damborg (eds.), Jessica Kingsley Publishing, UK. Kayasu, S. & Yasar, S. S. (2003) Regional Development Agencies: Suggestions for the Turkish Experience, In State Planning Organisation and Pamukkale University (Ed, KEAS) Kentsel Ekonomik Arastirmalar Sempozyumu, Denizli, pp. 348-357. Marcou G. (July 2006), Local Administration Reform in Turkey, A legal appraisal based on European principles and standards, Local Administration Reform Programme (Yerel Yönetim Reformu Program) Expert Reports. Pala, A. (2005) ’The Attempts in Regional Policy on the Road of EU Membership’, Unpublished Doctoral Report, Stuttgart: University of Tübingen.

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PNDP (Preliminary National Development Plan), Preliminary National Development Plan 2004-2006 (Ankara, DPT, 2003), December, www.dpt.gov.tr Republic of Turkey Council of State, 10th Division, Decree No: 2006/ 5588. Republic of Turkey Council of State, 10th Division, Decree No: 2006/ 6770. Turkish Government (2006) The Law on the Establishment, Coordination and Tasks of Development Agencies (Law No.5449, 25 January 2006), Turkish Government, Ankara. Yasar, S. S. (2003) Regional Development Agencies: Endogenous Dynamics and Regional Policy, Master's, Middle East Technical University, Ankara.

Notes i Provinces where the national income per capita for 2001 was less than 1,500 dollars and in provinces with negative socio-economic development index (SEDI) values in 2003, based on the condition to increase employment. ii

Regulation on the working procedures and principles of the development agencies.

CHAPTER TEN THE ROLE OF BEHAVIORAL ECONOMICS IN BOSNIA AND HERZEGOVINA: DOES REMITTANCES AND FOREIGN AID HAVE AN ADVERSE EFFECT ON ECONOMIC DEVELOPMENT? AIDA SOKO

Abstract: Transition countries with a high inflow of remittances and donor funds experience slow economic growth, low foreign direct investment inflow, and slow public administration reform. Countries in which the majority of investments are made by local or regional investors also record slower growth rates due to the overconfidence effect. Besides a high inflow of remittances and aid, as well as a low level of investment inflow from outside of the region, private sector development in Bosnia and Herzegovina is restricted by the public sector dominance in industries elsewhere traditionally served by the private sector. The main focus of this chapter is related to an analysis of five rational arguments commonly used as an explanation for why Bosnia and Herzegovina is lagging behind its peers among transition countries. The analysis questions the arguments’ rationality in comparison to peer countries, considers the rationality of public sector decision makers’ choices and explores the influence of irrational factors, in particular the effect of aid and remittances on economic growth. The research suggests the groundlessness of the rational arguments and confirms a reverse relationship between aid and remittances, and economic development in Bosnia and Herzegovina. It also implies that the decisions of policy makers in Bosnia and Herzegovina are driven by irrational factors influenced by principles of the Prospect and Disruptive theories, and the concept of leapfrogging.

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Keywords: Behavioural economics, Bosnia and Herzegovina, public sector, private sector, economic development.

Introduction Although behavioural economics has been a subject of interest for over 50 years, the global crisis has imposed an especially pressing need to reassess the influence of irrational factors on economic development. Bosnia and Herzegovina (BH) is exposed to a constant crisis, irrespective of the recent global one, and it is hard to find rational explanations for many developments. At the same time, there are insufficient empirical proofs to offer a quantification of irrationality, nor intensity and correlation between the “usual suspects” among variables that may have an impact on economic development. Behavioural economics is a combination of psychology and economy, and aims to find answers on market functioning in conditions where market players are exposed to limited human resources and where specific complications are in place. The influence of behavioural economics on public sector decision-makers is an area of particular interest for countries like BH. In general, a high inflow of remittances and donor funds is often followed by slow economic growth, low foreign direct investment (FDI) inflow and slow public administration reform. Specifically, those transition countries where major investors in the private sector are domestic or from neighbouring countries have seen slower economic growth. The lack of an entrepreneurial tradition, public sector dominance in the economy, the complex transition process and the low level of FDIs are the major challenges facing the economic growth of BH. Generally speaking, Bosnia and Herzegovina is not the only country that has a complex administrative structure and a turbulent history, even within the region. There are a number of developed countries that have complex administrative structures as well, and which are still very efficient in an economic sense (Canada, Belgium, and Switzerland). BH is not the only transition country that has to pass through structural reforms and make the full turnover from relying on large state-owned enterprises to a market economy based on smaller-scale private ownership. There are rational rules for economic models, the experiences of transition countries, and lessons learnt on how political issues can be resolved in an economically efficient way. Why then is the Bosnian case so specific? Are there rational reasons, or should we seek other types of explanations?

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Methodology This research combines qualitative and quantitative analysis of the role of behavioural economics in the economic development of Bosnia and Herzegovina. The qualitative part of the research includes a literature review relevant to the topic, as well as a comparative analysis of the countries in Southeast Europe (SEE). In the comparative analysis BH has been compared with seven SEE countries: Albania, Croatia, FYR Macedonia, Montenegro, Serbia, Romania and Bulgaria. For this purpose, data from the UNCTAD database and the World Bank Doing Business Database have been used. The core part of the research is a quantitative analysis of the interrelations between remittances and donor funds, as the dependent variable, and economic indicators (gross domestic product per capita, foreign direct investment inflows per capita) as the independent variables. For this part of the research, the UNCTAD database has been used. Data used in the analysis for BH and selected countries are remittances, foreign aid, gross domestic product (GDP), FDIs, as well as data about population for the calculation of per capita values. The theories used in the interpretation of the results include the prospect theory, disruptive theory and the concept of leapfrogging, while the correlation analysis of remittances/grants and economic development indicators is used in data analysis.

Problem Analysis: Why Behavioural Economics? Traditional financial economic theory assumes that market players in economy are rational and make unbiased forecasts. The roots for this are the work of Daniel Bernoulli, the famous mathematician who also made significant scientific contributions in other areas, including probability. In his work, he underlined that mathematicians, for the sake of theory, measure money by quantity, while in real life people with common sense measure money by the utility they can obtain from it (Bernoulli, 1954). Economic behaviour has been the subject of much research. While studies attempted to find patterns and axioms based on rationality in order to find better mathematical models to explain economic behaviour (Neumann and Morgenstein, 1947; Kauder, 1965; Stigler, 1968), psychologists heavily criticised this concept, arguing that people do not consistently follow the rules of rationality (Kahneman and Tversky, 1979; Hogarth, 1987).

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The most important critique, however, is known as the prospect theory (Kahneman and Tversky, 1979) which has empirically proven that people underweight outcomes that are merely probable for the sake of certain outcomes, and that there are inconsistent preferences whereby the same choice is presented in a different way. This has underlined a need to explore even further the area of behavioural economics and to invest more time in developing models that are able to take into account for these soft factors. In particular, it is interesting to explore the effect of these factors on public sector choices, and even more so their impact on transition countries. The major challenge of transition countries is to find proper policies and measures to boost their economic development. Furthermore, the global crisis and restricted possibilities for support from developed countries move the frontiers forward and require public officials and policy makers to think outside the box in searching for alternative solutions. This topic has been widely researched along with the effects of financial aid on the economic development of transition countries. Many authors have criticized the effects of financial aid on economic development (Griffin and Enos, 1970; Weisskopf, 1972; Easterly, 2003), while some have argued that positive effects are possible (Papanek, 1973; Gulati, 1978; Boone 1996), but only under a good policy framework (Burnside and Dollar, 2000). According to many authors and researchers, the area of behavioural economics in public finance is rather a milestone in resolving a puzzle of modern public finance challenges (Bernheim and Rangel, 200; McCaffery and Slemrod, 2004). It should not be simplified into the mere application of psychology in resolving economic issues, but rather to find out how psychological factors influence core concepts in public finance (Congdon, Kling and Mullainathan, 2011). Foreign aid may either boost or serve as infrastructure for FDIs, or obstruct private sector development by diverting funds towards unproductive activities (Harms and Lutz, 2006). There are a number of studies that have explored the topic of the influence of aid on FDIs and economic growth, but in the majority of them, SEE countries have been excluded from the overall analysis due to the lack of data. Therefore, it is quite important to undertake research based on transition countries comparable to BH.

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Doing the wrong things for exactly the right reasons… Humanitarian aid is a natural human reaction to terrible events such as war. But where is the bottom line? When should humanitarian aid be replaced by more sustainable efforts? How can relatives, friends and socially responsible companies/governments be convinced to transform aid into a more sustainable means of support? Transition countries have a lack of capital and are relatively rich in workforce and unexploited natural resources, all of which is quite the opposite in developed countries. Transition countries benefit from a high inflow of different forms of aid, including social, but also semicommercial in the form of soft loans, financing of reforms etc. Yet foreign aid does not come without conditions. There are clear rules, “carrots and sticks”, that support the transition process. In essence these rules actually replace managerial decisions, regardless of the sector where the intervention is made (private or public). In transition countries the role of the state is crucial, in particular when we consider ex-socialist countries. Not only is it impossible to press a magic button and change a style of government, it seems that the ultimate decision about promoting private investments and foreign direct investments is on the side of a state. Why would they change their monopolistic position? Although it is not the primary intention of the concept of leapfrogging, it could be well applied here: government has less and less incentive to seek innovation and development, for in doing so they would lose power. With the best intentions then to help citizens and the state led development progress comes actually a trend of further deterioration, or in the best case scenario stagnation. Remittances are rarely translated into Diaspora investments, and there are very few proven cases in which foreign aid has had positive effects on development (Uganda, Taiwan, and South Korea). Numerous studies have explored the adverse effects of foreign aid and remittances on economic development, identifying a negative correlation between intensive aid and economic growth. However, different backgrounds and political, cultural and other contexts make it hard to generalise conclusions and simply apply them to the SEE, in particular to BH. Despite the lack of historical and comparable data in the SEE to conduct comprehensive analysis, there is a sufficient level of data to confirm or reject the general pattern of the negative effects of intensive aid on economic growth and foreign direct investment inflow.

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Results: Bosnia and Herzegovina Aid vs. Foreign Direct Investment The significance of remittances and humanitarian aid was crucial for the post-war recovery of Bosnia and Herzegovina. As is visible from Figure 10-1, in 1998 remittances accounted for almost half of GDP. By 2012, remittances had dropped down to 11% of total GDP. At the same time remittances were as high as 180% of total trade in 1998, declining over time to about a third of total trade in 2012. Figure 10-2 shows time series of remittances, aid and FDIs per capita in BH during the period 1998 to 2012. In particular, remittances recorded ups and downs, and they are still at a relatively high level. Aid per capita was higher in the post-war years, while afterwards it remains more or less stable, whereas FDIs had a very unstable path, reflecting the lack of a systematic approach to promoting investment. It may seem to be a paradox, but to attract FDIs you need to have a strong state that will guarantee stability. Getting back to the basics of behavioural economics rational choices should be directed towards engaging post-war aid to boost economic growth and cultivating the diaspora as a source of economic potential. As said earlier, however, you cannot simply press a button and change the mode in which a government operates. A planned economy cannot become a market economy over night: there is no accumulation of private domestic capital, without reforms there is no chance to attract FDIs, privatisation was a social compromise instead of an economic development accelerator, etc. The rational choice would be to structure privatisation in a way that enables the flow of new technologies, increased productivity and efficiency, and as a final effect, sustainable economic development. By contrast, privatisation was driven by social pressure giving preference to those who agreed to keep workers employed instead of to investors who offered new investments. As a result there are very few cases of successful privatisation, and a business-enabling environment remains complex and unattractive, despite many programs and reform attempts. The state turns to the only possible option and invests by itself, keeping the key sectors under its control (energy, telecommunication), creating a vicious circle. With the intentions of keeping social problems under control, economically irrational choices are made that buy more political points in the short run.

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Figure 10-2: Relation of remittances, aid and FDIs per capita in BH (in USD)

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FDI per capita

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With high unemployment rates, unregulated vocational education, weak programs on life-long learning, and in particular without any workforce development strategy linked to private sector needs, the chances for the majority of BH citizens to find a job are declining. At the same time, the level of remittances is relatively high, which helps recipients to survive, while at the same time creating even deeper problems. High emigration rates, estimated at one third of university-educated youth, have added more complexity to the issue. The most exploited excuses for these irrational choices are related to the complex administrative structure of the country, political instability, its negative image, transitional issues and a lack of funds. But if we make a comparison with countries in the region, we would not find significant differences between them and Bosnia and Herzegovina when it comes to historical heritage and political structure. It is obvious that BH is lagging behind its peers in the SEE region. Figure 10-3 shows average remittances and FDIs per capita in the period 2002 to 2012, confirming that BH has the highest misbalance between these two categories. Each of the SEE countries has its own structural challenges: Bulgaria and Romania are still suffering from the economic consequences of joining the European Union too early, FYR Macedonia and Serbia are still experiencing ethnic conflicts which escalate from time to time, and Croatia is struggling with external debt. Albania and Croatia, for example, have four levels of government, but they have found a way to make them efficient, unlike BH, which has three levels, high inefficiency and overlapping jurisdictions. A comparison of the progress in business-enabling environment reforms shows that BH by far has the worst ranking in the region in terms of the ease of doing business as per the World Bank Doing Business 2014 report. Out of the 189 economies ranked, BH takes 174th place in terms of starting a business, which is the basic milestone for the business environment. Peer countries in this principle have the reverse order in their starting a business rank - the best ranked is FYR Macedonia (7), while after BH, Croatia has the worst rank in the region (80).

CTAD stat; data retrieved d from http://unctadstat.unnctad.org/EN/ Source: UNC

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Figure 10-3: Comparison of SEE coun ntries (average 2012 to 20002 in USD)

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Starting a Business (174)

ng Credit Gettin (73)

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Figure 10-4: Ranking in ease of doing g business 2014

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The following Table summarises the most frequently used rational arguments used as explanations for why BH lags behind its peers in terms of economic development. Table 10-1: Summary of arguments Rational arguments

Comparison to peers

BH context

Political instability

None of its peer countries are politically stable, ethnic conflicts are still present - in some neighbouring countries conflict is still at a violent level.

Many of the reforms needed to improve the business environment are non-political or ethnic, but rather require administrative effort which starts at the local community level - for example, where business registration is done.

Negative image stops investors

None of the countries in the region have a positive image, but rather the negative “Western Balkan” image.

Still, BH has the lowest level of FDIs per capita among its peers and the highest level of remittances per capita.

Transition issues

Some countries in the region had to undertake even more radical economic reforms, moving from fully closed countries to open economies, while others shared BH’s history in the former Yugoslavia.

BH’s transition challenges are at least at the same level as those of their peers, if not even easier compared to some countries.

Levels of the Government (Administrative structure)

Even though Albania and Croatia have four levels of government they still have a more efficient system, therefore it is not about levels but about efficiency.

The complexity of the administrative structure is definitely an obstacle, but countries in the region, as well as more developed countries, have found ways to make this system efficient.

Lack of funds

All of the countries in the region have received and are still receiving substantial amounts of financial support in the form of foreign aid, international programs, European Union funds, etc.

Access to funds for financing reforms is relatively easily available. It all depends on the country’s capacity to absorb funding and use it efficiently.

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Conclusion In looking at rational explanations for BH’s slow progress in economic development it is hard to find arguments that explain the current deadlock, and the strong influence of irrational factors may be observed. Different aspects of the overall status of peer countries have been analysed and all of the Southeast European countries show far better performance and efficiency in creating reforms for a business-enabling environment while still facing the same types of issues as BH. Among its peers BH is the only one with a huge misbalance between remittances and FDIs per capita. After looking at these possible rational explanations we need to return to other possible patterns, as argued earlier in this chapter. The adverse effects of the different forms of aid on the reform environment and the development of managerial capacities in the public and private sectors is a common rule, and has been proven in the majority of cases. Bosnia and Herzegovina is not very different, but rather confirms the rule. A huge amount of aid in the form of remittances, foreign aid, and humanitarian aid “helped” the country lose momentum in the post-war period. “Thanks” to strong international support and a lack of domestic capital, the state remains the major entrepreneur, setting the tone in the business environment. About one quarter of all employed persons work in the public sector (including state-owned companies) and statistics report higher salaries for these positions than in the rest of the economy. Bearing that in mind, it is not surprising that BH has the lowest level of foreign direct investment per capita in the region. At the same time, BH has the highest level of remittances per capita among its peers. Remittances help citizens “survive”, but the truth is that these remittances make people reluctant to take action and explore the possibility of starting their own business or generally becoming active participants in creating new value instead of reliance on social transfers. Does the flow of remittances slow down economic reforms? Judging by the case of BH it clearly does. Are remittances needed for BH citizens to “survive”? Again: yes. Or in simple words: The road to hell is paved with good intentions and the road to failure is paved by the same.

References Bernheim B.D. & Rangel A. (2007). Behavioural Public Economics: Welfare and Policy Analysis with Nonstandard Decision Makers. Princeton: University Press.

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Bernoulli, D. (1954). Exposition of a new theory on the measurement of risk. Econometrica, 22(1), 23-26. Boone, P. (1996). Politics and the effectiveness of foreign aid. European Economic Review, 4 (2), 289-329. Burnside, C., & Dollar, D. (2000). Aid, Policies, and Growth. American Economic Review, 90(4), 847-868. Congdon W.J., Kling, J.R., & Mullainathan, S. (2011). Policy and Choice: Public Finance through the Lens of Behavioural Economics. Washington, D.C: Brookings Institution Press. Easterly, W. (2003). Can Foreign Aid Buy Growth? Journal of Economic Perspectives, 17(3), 23-48. Griffin, K. B., & Enos, J.L. (1970). Foreign Assistance: Objectives and Consequences. Economic Development and Cultural Change, 18(3), 313-327. Gulati, U.C. (1978). Effect of Capital Imports on Savings and Growth in Less Developed Countries. Economic Inquiry, 16(4), 563-69. Harms, P., & Lutz, M. (2006). Aid, Governance and Private Foreign Investment: Some Puzzling Findings for the 1990s. The Economic Journal, 116(513), 773-790. Hogarth, R.H. (1987). Judgment and Choice. New York: John Wiley and Sons. Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision Under Risk. Econometrica, 47, 263-291. Kauder, E. (1965). A History of Marginal Utility Theory. Princeton: University Press. McCaffery, E.J., & Slemrod, J. (2006). Behavioural Public Finance: Toward a New Agenda. New York: Russell Sage Foundation Press. Papanek, G.F. (1973). Aid, Foreign Private Investment, Savings, and Growth in Less Developed Countries. Journal of Political Economy, 81(1), 120-30. Stigler, G.J. (1950). The Development of Utility Theory II. Journal of Political Economy, 58(4), 307-327. Von Neumann, J., & Morgenstern, O. (1947). Theory of Games and Economic Behaviour. Princeton: University Press. Weisskopf, T.E. (1971). The impact of foreign capital inflow on domestic savings in underdeveloped countries. Journal of International Economics, 2(1), 25-38.

CHAPTER ELEVEN THE EXCHANGE RATE AND ITS CONNECTION WITH IMPORT-EXPORT ALBA CANI

Abstract: This study examines the effect of exchange rate volatility in imports and exports by using simple regression analysis with the exchange rate as the independent variable and import-export as the dependent variable. Thus, an empirical method is used to prove whether a relationship exists between the exchange rate and import-export. All the data are taken from the Bank of Albania and Albanian Institute of Statistics websites. All the quantitative data regarding the considered variables are expressed in millions of Albanian Leke. The analysis is based on values of the mentioned variables covering the period of 1996 to 2013 for the LekeUSD exchange rate and the period of 1999 to 2013 for the Leke-Euro exchange rate. According to the findings, it is clear that the exchange rate volatility does not have a significant impact on imports because some products that Albania imports are basic products, considering the inelastic demand of these products. On the other hand, exchange rate volatility affects exports as exports are directly related with exchange rate volatility. Keywords: Exchange Rate Volatility, Import, Export, Regression Analysis

Introduction Recently, trade agreements and exchanges among different countries are becoming important. Exchange rate and its volatility are important elements taken into consideration whenever these trade agreement and exchanges are made. The history of Albania has had significant developments in different periods. The most important economic undertakings in Albania during the transition period are the actions toward

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the adoption of a flexible exchange rate. This has had its positive impact in improving the position of our country, either as an exporter or as an importer of goods. After the adoption of a flexible exchange rate, there has been debate regarding the impact of exchange rate fluctuations on international trade. According to some theoretical literature, this impact might be positive or negative. Nevertheless, a few papers give credentials and confidence on whether exchange rate volatility affects trade flows among countries. One of the ways that the exchange rate could affect trade flows is by influencing the uncertainty of prices and profits. Moreover, if exchange rate fluctuations continue for a considerably long time, it might cause domestic producers to reduce the purchasing power toward foreign markets thus reducing the volume of trade. One of the factors that affect imports beside the exchange rate fluctuation is the level of income. Consequently, it is logical that an increase in income level will cause increased consumption. The effect of exchange rate on imports is negative, especially in case of an appreciation of the foreign target currency where the goods are imported. Considering the above mentioned information, this chapter is an attempt to explain the relationship between the exchange rate and exportimport. This study examines the effect of exchange rate volatility on imports and exports by using simple regression analysis with exchange rate as independent variable and export-import as dependent variable. The organisation of the chapter is as follows: the first section as follows is the literature section which provides a view of the exchange rate fluctuation and its impact on exports-imports. The second section describes the related data and methodology, and follows with an overview of the exchange rate in Albania. Finally, a brief conclusion regarding the topic is provided.

Literature Review Different scholars have done extensive research on the impact of exchange rate volatility on the volume of international trade, taking into consideration that different countries have adopted the flexible exchange rate system. Albania adopted the flexible exchange rate at the beginnings of economic transition (Vika and Luci, 2011). Two important events which have prompted interest in the relationship between exchange rate volatility and international trade are: x Both the real and nominal exchange rates have experienced volatility since 1973.

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x During the last decade, international trade declined significantly among industrialized countries. According to empirical literature, the effects of exchange rate on imports are equivocal. Based on the findings of Godwin (2009), Arize (1998) and Pozo (1992), there is a negative correlation between exchange rate volatility and imports. On the contrary, Agolli (2003) finds positive evidence for imports volatility including developing countries. Aristotelous (2001) and Hooper and Kohlhagen (1978) have affirmed no significant relationship between exchange rate volatility and imports, and this result is valid for developing countries and Albania as such. Exchange rate fluctuation does not have an impact on imports in developing countries because developing countries purchase basic goods and the demand for such goods is inelastic. Developing countries are indifferent of the imported good’s price because they do not have the capacity to produce these products and no substitute product is found for them. Darva (2012) and Darva and Pierre (2010) observed that large importers were also large exporters. Different empirical studies have been done to reveal whether exchange rate volatility influences trade. It is believed that exchange rate volatility impedes the growth of foreign trade. However, studies done by Aristotelous (2001) and Gagnon (1993) have not found any significant relationship between exchange rate volatility and trade. Exchange rate fluctuation has engendered theoretical and empirical studies regarding the issue of international trade. An increase in exchange rate volatility could have negative, positive or no impact on trade (Broll, Wahl, and Wong, 2006). This impact depends on the elasticity of demand for these products. According to findings of Bhattarai (2011) free independent exchange rate movements were not the result of central bank interventions. Some outstanding authors in economics such as Alam and Ahmed (2012) support the idea that the exchange rate should be determined in the market. On the other hand, Burstein and Jaimovich (2009) assert that a slight intervention of the Central Bank is needed to keep exchange rate volatility in equilibrium. These authors argue that setting a wrong exchange rate peg would significantly affect the import and export levels of the target country. According to findings of Chit, Rizov and Willenbockel (2010), if a country have a developing country status, with Albania being on that list, policymakers initiate the movement associated with the exchange rate. They argue that exchange rate policies have a crucial impact on the nature of international trade among countries.

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Empirical Study-Data and Methodology The Impact of Exchange Rate Fluctuation in Exports-Imports Data The data used for regression analysis are taken from INSTATiand the Bank of Albania. The data for the exchange rate are taken from the Bank of Albania whereas the data for exports and imports are taken from INSTAT. Table 11-1: Description of variables and their sources Variable

Explanation

Source

Exchange Rate

Annual exchange rate of Leke-USD and Leke-Euro (1996 to 2013)

Bank of AlbaniaMonetary policy, exchange rate archive, exchange rate by year

Import

Flow of Albanian imports expressed in Albanian Millions Leke, annual data.

INSTAT-Publication, external trade, flow of goods in foreign trade, foreign trade by group commodities.

Export

Flow of Albanian export, expressed in Albanian Millions Leke, annual data.

INSTAT-Publication, external trade, flow of goods in foreign trade, foreign trade by group commodities.

Methodology Exchange rate fluctuation has a statistical significant effect on export and an insignificant effect on imports. This study makes an examination of the effect of exchange rate fluctuation on export-import using data from INSTAT and the Bank of Albania. The regression model is run for a period of 18 years for the Leke-USD exchange rate and from 1999 to 2013 for the Leke-Euro exchange rate. Based on the model, an appreciation of Leke currency will decrease the exports making Albanian products more expensive. On the other hand, considering imports, the model is statistically insignificant and the exchange rate fluctuation does not have any impact on the volume of imports. The main objective of this study is

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to evaluate the relationship between exchange rate volatility and exportimport levels. Thus, the research question is: “Does exchange rate volatility affect the levels of export-import?” The regression model and a detailed explanation of regression analysis give full insight on answering this question.

Overview of Exchange Rate in Albania The Exchange Rate in Albania The exchange rate has played a key role in our country's macroeconomic stability. Since the fall of communism, Albania implemented a fixed exchange rate regime against the USD and later on, it was substituted by a flexible exchange rate regime implemented in 1992, in line with the stabilization program supported by the IMFii. Long term analysis of the exchange rate is suitable for the situation, as based on the relationship of exchange rate with import-export over a considerable period of time. Although a flexible exchange rate needs self-regulation through market mechanisms, it is observed over the course of years included in the study that this mechanism needs external intervention. The Albanian Central Bank has the role of regulation and has formulated a set of laws and guidance articles. In Figure 11-1, the change in the real exchange rate in Albania from 1996 to 2013 is shown with relation to two major foreign currencies (Euro and USD). In the first years of this period, the local currency was linked to the USD while later it shows a strong connection with the Euro as the common European currency. This is explained by a geographical proximity and the increasing trade exchanges there are with the European Union (EU) countries. During the transition years (until 1998) Albanian currency devaluated significantly against the USD. The peak of devaluation was reached from 1997 to 1998 as a consequence of the economical and political conditions of this period. During the years from 2000 to 2002 it was obvious that the Leke was worth less than the Euro and more than the USD. The strong economic development of the United States at this time greatly strengthened the USD. In contrast, the weakness of the Albanian banking system was shown by the invasions at bank counters and massive withdrawals of deposits in 2002. These were caused by unsuccessful attempts to privatise the most important Albanian state-owned credit institution called the Savings Bank. Another reason was the high political instability caused by the collapse of pyramid schemes in 1997. The Central Bank mitigated the crisis by providing liquidity assistance to several large credit institutions in

Source: Bank of Albania, 2013

Figure 11-1: The exchange rate Leke-Euro and Leke-USD in the years 1996 to 2013

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difficulty and strongly increasing the repurchase agreement rate. After 2002, the USD depreciated significantly compared to the Leke, which happened because of the declining confidence in the U.S. currency internationally as a result of the depreciation of the dollar from the U.S. government. The exchange rate of the Euro with the Leke has maintained a stable level because the liquidity problems of credit institutions were solved. Contrary to 2002, in 2003 and early 2004, the Leke was under appreciation pressure, which was rejected by Central Bank interferences. Again, by the end of 2004, the real effective exchange rate was significantly higher than that of the year before, exerting pressure on the competitiveness of Albanian exports. In April 2004, after the restructuring measures, the largest bank of the country, the Savings Bank of Albania (representing over half of the total bank deposits) was privatised by an Austrian strategic investor, Raiffeisen Zentralbank. This fact contributed to increased reliability. Generally, we can assume that after 2000, Albania has reached significant stability regarding their currency towards those two main foreign currencies, which explains the progress and increased confidence of the domestic currency and monetary policy despite various obstacles.

The Exchange Rate and Import-Export Developments in the external trade flows can have very large consequences in small open economies, as in the case of Albania. For this reason, their trends are followed closely by markets and decision makers who develop macroeconomic policies (Vika, 2009). Recognition of the trade balance helps decision makers choose between trade policy and exchange rate depreciation alternatives in order to improve external trade position with the rest of the world. Thus, the forecast supply for exports and the demand for imports help shape their policies. As mentioned earlier in this chapter, focus is on the long-term analysis model that relies on the traditional economic theory on foreign trade. This theory links the amount required for imports (exports) with internal revenue growth (external), developments in domestic and foreign prices, as well as changing the value of the domestic currency. To support this theory’s implementation in the economy, the research task was concentrated on the study of Vika (2009). According to this study, in which the volume of imports (exports) of goods is determined by domestic/external demand, relative prices, and the exchange rate, the following results are found:

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(I) Complete response of imports and exports tended to have less impact on changes in the exchange rate than on changes in prices. (II) Trade flows were initially more sensitive to fluctuations in the exchange rate than to changes in prices. (III) After comparing the performance of imports and exports in the economy before and after the fixed exchange rate system, it was concluded that floating exchange rates are important determinants of flows of imports and exports. The following analysis will be conducted based on the above results, especially focused on the third point.

Exchange rate and exports Between exchange rate and exports, there is a special connection. Given that the exchange rate is the relative price of domestic currency versus that of the foreign one, it depends on the developments in monetary conditions of both economies. Theoretically, when real interest rates in the domestic economy grow, we can expect a currency appreciation of that economy. The increased value of the domestic currency makes domestically produced goods more expensive than imported goods and it can lead to a reduction in net exports. Based on the charts below, we aim to analyse the relationship of the exchange rate, initially with exports and then imports. According to the data provided by INSTAT (Instat Albania, 2013), Albania exports the following commodities 1. Textiles and footwear 2. Minerals, fuels, electricity 3. Food, beverages, tobacco In 1999, when the Euro was introduced, this currency had an impact on exports causing its level to increase compared with previous years. After 2004, the exchange rate of the Euro-ALL has maintained a stable level, whereas exports–imports level has had a steady upward trend. In 2007, there was a significant increase in exports. The main reason for this increase was the signing of CEFTAiii agreement, which predicted the increase of commercial exchanges among these countries due to the removal of barriers. This agreement contributed significantly to the growth of exports of fuels. In 2009, there was a decrease in exports caused not only by the global crisis but also by the decline in the processed minerals. In 2010, a depreciation rate of the Leke led to an increased demand in cheaper domestic goods.

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Source: INSTAT A., 2013

Exports-Imports of Albania 1993-2013

Figure 11-2: Exports-imports of Albania from 1993 to 2013

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Eksporti Export

Importi Import

Source: INSTAT A., 2013

Figure 11-3: Exports according to the products (1993-2013)

Food, beverages, tobacco

Minerals, fuels, electricity

Textile and Footwear

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Exchange rate and imports According to data from the balance of foreign trade, it is seen that Albania is mainly importing three categories of commodities: 1. Food, beverages, tobacco 2. Leather and leather manufactures 3. Machinery, equipment and spare parts As a result of: • Technological changes or various production functions and • Changes in community preferences The exchange rate does not have a direct impact on imports. Therefore, despite exchange rate fluctuations, Albania imports these products due to the increased demand for them, with the demand being inelastic. When a country is dependent on the imported products, the domestic currency fluctuations become unimportant because the country is obliged to buy them. An important commodity for the Albanian economy is oil, whose price is in USD. The appreciation of the dollar in this period (depreciation of the Leke) would bring a higher price of oil. Thus, the imported oil would be more expensive which is linked to the elasticity of demand which is lower in those countries that import this product. Albania, as a country in transition, has had difficulties even in the energy sector. From being an exporter of electricity until 1992, Albania became an importer since 1998, due to the rapid growth of energy demand. As most of the energy is produced by hydropower sources then, it is directly affected by weather conditions (precipitation). Periods of drought such as from 2000 to 2002, and 2006 to 2007, made it impossible for domestic energy production to cover domestic demand and thus an increase of its import was obvious. The downward trend of imports during 2008 to 2009 is due to the global crisis which initially originated in the U.S. and then spread throughout the world. In 2010, positive results foretell a recovery from the crisis.

Source: INSTAT A., 2013

Figure 11-4: Imports according to the products (1993-2013)

The Exchange Rate and its Connection with Import-Export

Food, beverages, tobacco

Leather and leather manufactures

Machineries, equipments and spare parts

221

Results In this chapter, the regression between the exchange rate of Leke-USD and Leke-Euro and export-import is analysed. There are two regression equations. The first equation shows the relationship between exchange rate volatility and exports where the level of exports is the dependent variable and the exchange rate volatility is the independent variable. Accordingly, the second equation depicts the relationship between the exchange rate volatility and imports in which the imports level is the dependent variable whereas the exchange rate is the independent one. The regression equation is: Y= ‫ ޔ‬ȕo+ ‫ ޔ‬ȕ1*X + u: X – is the independent variable, in this case the exchange rate Leke- USD, Leke-Euro Y – is the dependent variable, which is being predicted, in this case export/ import ȕ– is the expected intercept parameter, which equals the value of Y when the value of X=0 ȕ1– is the expected slope, which tells how much Y changes for a given unit change of X u – error term or disturbance term, the error in predicting the value of Y, given the value of X It is visible that an appreciation of the Leke as compared to the USD will reduce the level of exports as Albanian products become too expensive for foreigners to afford them. On the other hand, the exchange rate fluctuation does not have a significant impact on the imported products of Albania toward Italy, Greece and Turkey.

Regression Model I: Relationship between Exchange Rate and Exports Equation (1) is: Y= 270701 – 1561.716*X Y—is the dependent variable; the level of exports expressed in millions Albanian Leke X—is the independent variable; the exchange rate denominated in LekeUSD

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Table 11-2: E-views Output, relationship between exchange rate and exports Coefficient

Std Error

t Statistic

Prob

C(1)

270701.4

74836.64

3.617231

0.0023

C(2)

-1561.716

639.3953

-2.442488

0.0266

R-squared

0.271593

Meandependent var

91286.34

Adjusted Rsquared

0.226068

S.D.dependent var

69009.05

S.E. of regression

5.90E+10

Schwarz criterion

25.06896

Log likelihood

-222.7303

HannanQuinn criter

24.98367

F-statistic

5.965749

DurbinWatson stat

0.277015

Prob(Fstatistic)

0.026569

Regression Model II: Relationship between Exchange Rate and Imports Equation (2): Y= - 41299.80 + 2853.5*X Y—is the dependent variable; the level of imports expressed in millions Albanian Leke X—is the independent variable; the exchange rate denominated in LekeEuro

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Table 11-3: E-view output, relationship between imports and exchange rate Coefficient

Std Error

t Statistic

Prob.

C(1)

-41299.80

694479.0

-0.059469

0.9535

C(2)

2853.527

5234.620

0.545126

0.5949

0.022348

Mean dependent var

336722.2

Adjusted Rsquared

-0.052856

S.D. dependent var

142088.8

S.E. of regression

145795.6

Akaike info criterion

26.74136

Sum squared resid

2.76E+11

Schwarz criterion

26.83577

Log likelihood

-198.5602

HannanQuinn criter

26.74036

F-statistic

0.297162

DurbinWatson stat

0.091777

Prob(Fstatistic)

0.594896

R-squared

Equation (1) is: Y= 270701 – 1561.716*X Y—is the dependent variable; the level of exports expressed in millions Albanian Lekë X—is the independent variable; the exchange rate denominated in LekeUSD The intercept would represent the value of exports if the exchange rate would not exist, meaning that the same currency is denominated in both countries; in the one who exports the products and the other one who purchases these products. The slope in this case is 1561.716 which shows the level of correlation between two variables and explains that a unit increase in X changes the expected value of Y by the amount of ȕ1. As the

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Ordinary Least Squares (OLS)iv estimate is unbiased because regression fulfills 4 assumptions of simple regression analysis, a 1% appreciation of Leke compared with the USD will decrease the value of exports by 1561.716 Leke. This result might be explained with the theory of increased prices. As the value of Leke in terms of USD increases, this means that Albanian goods and commodities become more expensive. Thus, the price of Albanian goods and commodities are higher causing the demand for these goods to decrease. As for the statistical significance, the two sided alternative with significance level Į= 5% and degrees of freedom 120 is chosen. The critical value is the absolute value of 1.96. The two hypotheses are: Ho: ȕ1=0 vs. H1: ȕ10 The rule is that Ho is rejected if: t > critical value, we have sufficient evidence of rejecting Ho in favor of H1 at a 5% significance level. In our case, t= - 2.44 while the critical value= -1.96. There is sufficient evidence of rejecting Ho in favor of H1 at a 5% significance level since the t statistical value falls in rejection region. Therefore, the ȕ1 coefficient is statistically significant which means that the value of ȕ1 affects the value of Y. Finally, the explanatory meanings of the statistics found are tested. As R2 is equal to 0.27, this means that only 27% of the change in level of exports can be explained by the volatility of the exchange rate. So the R2 shows that the exchange rate volatility Leke-USD explains about 27% of the variation in level of exports for this sample of 18 years. That means that 73% of the export level variations are unexplained. This lack of explanatory power may not be too surprising because there are many other elements that influence the level of exports; these factors are necessarily included in the error of the simple regression equation. Although R2 is not a considerably high value, we can say that it is still possible that the Ordinary Least Squares regression equation is a good estimate of the ceteris paribus relationship between the dependent and independent variables. A ceteris paribus relationship between dependent and independent variables means testing a causal relationship between the above mentioned variables with all other factors constant. Logically, this means that in our model of testing the causal relationship between import/export and exchange rate volatility, the other factor such as the level of income is held constant during the years of study. Therefore, when the relationship is ceteris paribus which means “other (relevant) factors are equal or constant”, we are able to find out the real causal effect that exchange rate fluctuation has on export/import level. If the relationship between variables would not be ceteris paribus then the effect of exchange

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rate fluctuation on import/export would not be clear. This concept can be easily understood in this way: for every point increase in exchange rate, the level of exports would decrease by a multiplier of 0.27. Equation (2): Y= - 41299.80 + 2853.5*X Y—is the dependent variable; the level of imports expressed in millions Albanian Leke X—is the independent variable; the exchange rate denominated in LekeEuro The intercept would represent the value of imports if the value of x would be 0 meaning that the exchange rate would not exist between countries. Slope is 2853.5 which shows the level of correlation between two variables and explains that a unit increase in X changes the expected value of Y by the amount of ȕ1. As the ordinary least squares estimate is unbiased because 4 assumptions of simple regression analysis are fulfilled, a 1% appreciation of Leke compared with the Euro will increase the value of exports by 2853 Leke. The 4 assumptions of the simple regression model which serve as proof for unbiased OLS estimate are: Assumption 1 (Linear in Parameters) In the population model, the dependent variable, y, is related to the independent variable, x, and the error (or disturbance), u, as y=ȕ0 + ȕ1x + u in which ȕ0 and ȕ1 are the population intercept and slope parameters, respectively. Assumption 2 (Random Sampling) We have a random sample of size n, {(xi, yi): i _ 1, 2 … n}, following the population model in the equation y=ȕ0 + ȕ1x + u Assumption 3 (Sample Variation in the Explanatory Variable) The sample outcomes on x, namely, {xi, i = 1… n}, are not all the same value. Assumption 4 (Zero Conditional Mean) The error u has an expected value of zero given any value of the

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explanatory variable. In other words, E (u/x) = 0. This result might be explained with the theory of decreased prices. If the value of Leke in terms of the Euro increases this means that foreign goods and commodities denominated in the Euro become cheaper. Thus, the price of foreign goods and commodities are cheaper causing an increased demand for these goods. As for the statistical significance, the two sided alternative with significance level Į=5% and degrees of freedom 120 is chosen. The critical value is the absolute value of 1.96. The two hypotheses are: Ho: ȕ1=0 vs H1: ȕ10 The rule is that we reject Ho if: t > c. We have sufficient evidence of rejecting Ho in favor of H1 at a 5% significance level. In our case, t=0.54 while the critical value=1.96. There is sufficient evidence of failing to reject Ho in favor of H1 at the 5% significance level since the t statistical value falls out of the rejection region. Therefore, the ȕ1 coefficient is statistically insignificant which means that the value of ȕ1 is not exactly 0 but near to 0. The fact that ȕ1 is statistically insignificant explains that exchange rate volatility does not have significant impact on import because some of the products that Albania imports are basic products taking into account for the inelastic demand of these products.

Conclusions It is not always easy to judge the exchange rate link with exportimport, especially in a country like Albania whose economy is in transition. Although Albania has a regime of a flexible exchange rate there are cases in which the Central Bank has intervened to regulate these fluctuations. There are cases of extreme economic situations in the country which have been closely related to exchange rate changes. Despite these cases, generally the exchange rate in recent years has been stable. Albania's external position, especially as the exporter of several commodities, has been directly linked to the exchange rate fluctuations during these years. As for imports, the same thing cannot be said, because there were other factors, such as the inelasticity of demands for some goods imported that has affected the demand despite fluctuation of the exchange rate. The adoption of a flexible exchange rate brought advantages to Albania as it improved its external position as an exporter to foreign countries. According to the regression model in which export level

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was the dependent variable it is concluded that the appreciation of the Leke as compared with the USD caused an adverse effect on Albania. This happened because the prices of Albanian products were inflated due to exchange rate volatility. The appreciation of the Leke in regards to the Euro increases the level of imported goods by improving the position of Albania as an importer. Albanians can buy more foreign goods and commodities as they become cheaper. In fact, according to the regression model in which the import level was the dependent variable there is statistical insignificance for ȕ1 meaning that the Albanian demand is inelastic for products like: machines and spare parts, as well as leather products. This model has a limitation due to one of the independent variables; income level is not included in the model. According to some economists, the level of income has an impact either on the level of exports or the level of imports. Regardless, the model is very important and it is an indicator and predictor of the trade volume between countries. The Central Bank of Albania as well as the State should regulate the exchange rate level between currencies in order to keep a stable level of exports and imports.

References Agolli, M. (2003). Exchange Rate Volatility Effect on Trade Variations,Albanian Center for International Trade. Policy Documentation Center , 1-3. Alam, S., & Ahmed, Q. (2012). Exchange rate volatility and aggregate exports demand through ARDL framework: An experience from Pakistan economy. Review of Applied Economics, 79-94. Aristotelous, K. (2001). Exchange Rate Volatility, Exchange Rate Regime, and Trade Volume: Evidence from UK-US Export Function (18891999). Economic Letters, 72(1), 87-94. Arize, A. C. (1998). The Effects of Exchange Rate Volatility on US Imports: An Empirical Investigation. International Economic Journal, 12(3), 31-40. Bank of Albania. (2011). Export and Import. Balance of Payments Buletin, 10-16. Bhattarai, K. (2011). Panel Data Models: Econometric Analysis. In Econometric Analysis, University of Hull, Business School. England. Broll, U., Wahl, J., & Wong, W. K. (2006). Elasticity of Risk Aversion and International Trade. Economic Letters, 126-130. Burstein, A., & Jaimovich, N. (2009). Understanding Movements in Aggregate and Product-Level Real Exchange Rates. Department of

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Economics, UCLA, working paper. Chit, M. M., Rizov, M., & Willenbockel, D. (2010). Munich Personal RePEc Archive. Retrieved from Middlesex University Business School, http://mpra.ub.uni-muenchen.de/9014/ Darva, Z. (2012). Real effective exchange rates for 178 countries: A new database , Bruegel Improving Economic Policy, Bruegel Working Paper (2012/06). Darva, Z., & Pierre, J. (2010, December). The Threat of Currency Wars: A European Perspective’,Bruegel Policy Contribution. Archive of European Integration (2010/12), p. 17. Gagnon, J. (1993). Exchange rate variability and the level of international trade. Journal of International Economics, 34 (3-4), 269–287. Godwin, A. (2009). The Effect of Exchange Rate Volatility on the Imports of ECOWAS Countries. The Social Sciences, 4(4), 340-346. Haderi, S. (2006). Kurset Nderkombtare te Kembimit. In S. Haderi, Paraja, Banka dhe tregjet financiare, Botimi III (pp. 179-246). Tirane: KRISTALINA-KH. Hooper, P., & Kohlhagen, S. (1978). The Effect of Exchange Rate Uncertainty on The Prices and Volumes of International Trade. Journal of International Economics, 8(4), 483-511. INSTAT, A. (2013). INSTAT, Imports. Retrieved from http://www.instat.gov.al/economicindicators/foreign trade/Tables/imports 1993-2013. —. (2013). INSTAT, Imports. Retrieved from http://www.instat.gov.al/economicindicators/foreign trade/Tables/imports 1993-2013. —. (2013). Instat Albania. Retrieved from Instat Albania: http://www.instat.gov.al/economicindicators/Tables/foreigntrade according to products 1993-2013. —. (2013). Instat Albania. Retrieved from Instat Albania: http://www.instat.gov.al/economicindicators/Tables/foreigntrade according to products 1993-2013. Peeters, M. (2005). What about monetary transmission in Albania? Is the exchange rate pass-through still the main channel? 5th International Conference "Central Banking in the time of integration" (pp. 211-233). Durrës: Bank of Albania. Pozo, S. (1992). Conditional Exchange-Rate Volatility and the Volume of International Trade: Evidence from the Early1900’s. Review of Economics and Statistics, 74(5), 325-329. Samanta, S. (1998). Exchange Rate Uncertainty and Foreign Trade for a Developing Country: An Empirical Analysis. The Indian Economic

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Journal, 45(3), 51-65. Vika, I. (2009). Matja e Funksionit te import-eksportit ne Shqipëri. Tiranë: Bank of Albania. Vika, I., & Luci, E. (2011). Ekuilibri i kursit real të këmbimit Lekë-Euro: Sa i shmangur është ai? - Material diskutimi. Tirana, Albania, Bank of Albania (pp. 9-25).

Notes i

INSTAT- Albanian Institute of Statistics

ii

IMF- International Monetary Fund

iii

Central European Free Trade Agreement, where the participant countries where South East European Countries: Albania, Bosnia and Hercegovina, Croatia, Serbia, Kosovo, Macedonia and Montenegro.

iv

OLS- Ordinary Least Squares Method

CHAPTER TWELVE WHAT ARE THE MEASURES FOR THE BEST FISCAL POLICY IN ALBANIA? BESJANA LAÇI AND EGLANTINA HYSA

Abstract Albania is a developing country that has had a difficult path in overcoming many social, political, and economic difficulties. After a period of communism, the biggest challenges for Albania were to pass to a free-market economy and to recover its economy. The free movement of people, capital, goods, and services pushed towards quicker progress. This chapter emphasises the importance of fiscal policies, such as government spending and tax collection, to foster and promote economic growth and to reduce poverty. The government needs to implement some stabilisation programs that aim to reach a sustainable, non-inflationary economy. Albania is currently using a flat-tax system, respectively a tax of 20% for consumption and 10% for income, as implemented in 2007. The main aim of this research is to examine the relationship between fiscal policy and economic growth, which is measured by GDP per capita, through regression analysis by incorporating the main fiscal indicators and defining the type of policy that has a better and stronger effect on the economy. The main issues discussed in this study are related to the analysis of the effects of government activities on economic growth, to the fiscal policy in Albania during the last decades, to the effectiveness of the tax system, and to the identification of the capacities of Albania to be a potential place for investment and to offer a positive business climate. Keywords: Government spending, tax system, economic growth, investment, business

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Introduction Many countries in Europe have experienced numerous unpredicted situations within the economic cycle. The recession during the beginning of 2009 was the downturn of the business cycle, which brought significant changes regarding unemployment, incomes, and prices. All of these economic indicators definitely have caused significant changes in the economy of each country. However, the economy of Albania has shown progressive growth each year. Debt is one of the most important components because of its crucial effect in the economy. According to the Maastricht criteria, the debt level for every country should be at 60%. In case that a country exceeds this level, known as a red alarm, the respective country has to intervene to reduce it. Albania’s debt is about 61%, which means that Albania should work on lowering its debt. However, this debt is not very high compared to the Maastricht criteria. This chapter investigates the main fiscal indicators such as government spending and tax system, and the effects of these policies in the economy of Albania. The first section explains the main literature review, which is based on the two most important theories: Keynesian and Neo-classical theory. This section starts by showing a positive relationship between government spending and economy, and a negative relationship between tax and economic growth. The aforementioned statement failed to predict those relationships in Albania according to some authors. In the case of Albania, studies showed that a reduction in taxes increases consumption and stimulates the economy of the country. The second section introduces the fiscal policy in Albania during the 1998 to 2010 period. The data begin after 1997, a year during which Albania suffered an internal political crisis, in order to determine how the economy reacted and if it showed positive progress. During this period, Albania adopted some stabilisation programs as suggested by the International Monetary Fund (IMF) and the World Bank. The main aims of these programs were to reach a non-inflationary and stable economy, and to reduce poverty. This section shows that government expenditures exceeded government revenues, which means that the government should intervene to stabilise the situation. The following section explains the tax system in Albania. Currently, Albania is using the flat tax system which consists of 10% for income and corporate tax, and 20% for Value Added Tax (VAT). Under this tax system,

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all people are treated equally and there is no distinction between the poor and the rich. Like the progressive tax, the flat tax also has its advantages and disadvantages. The main problem with this tax is that there is no distribution of wealth. However, one of the advantages of the flat-tax system is that it reduces corruption and fraud. The fourth section of this chapter investigates Albania as a potential country in which to invest. During the last decade, the total number of investments has risen in Albania, which means that not only domestic investors but also foreigners find Albania to be a suitable country in which to invest. There are some other factors like geographical position, transportation via air, sea, and land, low-cost labour, etc., that favor more investment in Albania. The next section explains the relationship between GDP per capita and three fiscal indicators such as current expenditure, capital expenditure, and VAT; the regression shows which of the variables is most significant. The last part of this study comes with conclusions presenting the main findings.

Literature Review Many studies are concerned with the effectiveness of fiscal policies on economic activity. These policies have been crucial components in determining economic development, and often they have played an important role in the progression or regression of the economy. Almost all of these studies are based on the two most important schools of economic theory: Keynesian and Neo-classical theory. According to the research paper of Xhepa (2000), the Keynesian theory implied that if there was an increase in taxes, or a decrease in government expenditures, the output level would decrease. On the other hand, Neo-classical theory showed how the decrease in budget deficit positively affected the economy of the state. However, economic growth can be influenced by fiscal policy through the production of capital, which leads to an increase of output and encourages more investments. Blanchard and Perotti (1999) investigated the response of the economy to the shocks in fiscal indicators, such as government spending and tax collection shocks, in the United States. They applied the VAR approach by collecting data during the post-war period, where they found that the largest tax cut was signed in the second quarter of 1975. According to their study, the rise in government spending positively affects the output, while the rise in taxes has a contrary impact. They further investigated that both

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a rise in government spending and in taxes showed a strong negative impact on investment spending. In their working paper, they concluded that a government spending shock leads to an increase in private consumption and a decrease in private investment. Thus, in this case, both imports and exports fall. In the view of Easterly and Rebelo (1993), there existed a strong relationship between fiscal policies and the development of the state. Their study was based on cross-sectional data over the 1970 to 1988 period. In their working paper, they clearly stressed that poor countries are the ones that rely more on the taxes imposed on traditional trade. On the other hand, they confirmed that taxes on income are more important for developed countries. These statements clarify the idea that economic growth is affected by a rise in taxes. Still, the authors stated that the activities of investment became less attractive, since the increased income tax led to lower net return rates from private investment. The Knight, Loayza, and Villanueva (1993) study examined the effect of tariffs on economic growth by taking into consideration some panel data from 98 countries from 1960 to 1985. They concluded that countries that have lower tariffs on intermediate and capital goods grow faster compared to countries that have higher tariffs. In this context, the increase of tariffs on these goods would slow down the economic growth of the country. Even though they reduced the sample observations to 76 countries, the result was the same. Thus, according to this study, even if researchers further increase or decrease the sample, the result is concerned more on lower tariffs, which are helpful in positive movements of economic activity. In addition to tariffs on goods, foreign direct investment also plays a very crucial role on the growth of economy. In their research paper, Borensztein, De Gregorio, and Lee (1998) suggested that foreign direct investment is a transfer vehicle of technology that contributes more to economic growth as compared to domestic investment. These authors investigated the impact of foreign direct investment on the economy from 1970 to 1989 by considering a sample of 69 developing countries. After all needed data was collected; they reached a conclusion that stated that the increase of foreign direct investment was helpful on economic growth. However, they mentioned the importance of human capital level in the host country in the utilisation of foreign direct investment and its effects on economy. The contribution of foreign direct investment to growth is done in two ways. Firstly, it increases the overall investment level by encouraging higher domestic investment levels without the human capital

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interaction. Secondly, when human capital interacts with overall investment levels, then foreign direct investment is more attractive and productive in comparison with domestic investment. Lee (1994) presented the economic growth of countries by examining the domestic and foreign-capital goods’ effects on the income growth rate. In his study, he considered 89 countries during the 1960 to 1985 period. He concluded that if a country had more imported goods as compared to its domestic goods, then this country had a higher income growth rate. Higher growth rates of income lead to faster economic growth. Through regression analysis, he concluded that the import ratio in investments had a positive effect on the growth rate of income, and the share of total imports in GDP had no significant effect on growth. This means that investment is a very important factor to be considered when observing the growth of an economy. After the author restricted the sample to 68 countries, the result was the same as in the first one. Some other economists focus on the importance of exports rather than imports. The authors Krueger (1979) and Otani and Villanueva (1990) investigated a strong positive relationship between exports and economic growth. As the number of exports increase, the output growth will be encouraged to increase too. According to them, this relationship was stronger for lower and higher-income developing countries and weaker for middle-income countries. There are a lot of studies that show the direct influence of government spending on economic growth. According to Landau (1986), government spending generally has no significant influence on the growth of output. His study was based on 65 countries during 1960 to 1980. On the other hand, Hadjimichael, Dhaneshwar, Martin, Nord, and Ucer (1995) drew data from 39 African countries from 1886 to 1992 and concluded that government expenditure positively affected both output growth and investment. This strong positive association implied that an increase in government spending will lead to an increase in investment and output growth. However, what is the main reason for these two contrasting results? In our opinion, these results differ from each other due to the change in the time periods. Even though the second study used less data as compared to the first one, it concluded that a strong relationship between fiscal indicators and output growth existed. In the case of Albania, the study of Mançellari (2011) showed the relationship between fiscal policy and economic growth. He took into consideration four main macroeconomic indicators such as fiscal policy,

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interest rates, gross domestic product, and price level. This working paper studied the effects of fiscal policies on these macroeconomic variables. His analysis found that there was a strong fiscal-growth association, in which a tax reduction led to higher consumption and lower interest rates. The contrasting result occurred with prices because a cut in revenues caused a decrease in the price level. Regarding expenditures, capital expenditure had a higher effect on GDP in comparison with current expenditure. Neither capital nor current expenditure shock had any significant effect on interest rates. The research study by Shijaku and Gjokuta (2013) was also based on the effects of fiscal policy on economic growth in the developing country of Albania. They concluded that government revenue affects economic growth more than government expenditure. In their paper, they also found that an increase in public debt would cause a decrease in the growth rate, which shows a negative relationship between public debt and economic growth. According to this study, tax revenue was categorized into distortionary and non-distortionary, while government spending was categorized into productive and non-productive. In this case, they found that distortionary taxation has a higher significant effect on economic growth than non-distortionary taxation. On the other hand, productive expenditure positively affects growth, while non-productive expenditure negatively affects it.

Fiscal Policy in Albania Albania is a country that has passed through a difficult transition period since the beginning of 1990s. Changing from a planned economy to a freemarket economy caused volatility in many of the main macroeconomic variables like prices, shifts in demand, interest rates, GDP, etc. The government was the main agent that could consider some regulations in order to stabilise the economy and achieve a non-inflationary economy. Through its regulations by fiscal consolidation, the government’s aim was to decrease budget deficit, to regulate the tax system, and to reduce the public debt. In this chapter, the data are taken from INSTAT, IMF, World Bank, and the Ministry of Finance over the period 1998 to 2010. The data were taken after the war in 1997 in order to see how the economy was affected by fiscal indicators. Since the Albanian economy passed through a slowdown period, it was necessary to implement a stabilisation program known as the Enhanced Structural Adjustment Facility II (ES AF II) program. It was an

W What are the Meaasures for the Best B Fiscal Policcy in Albania?

237

IMF program m that aimed at the reduction of povertyy, and the sustainability and stabilityy of macroeconomic factors. The resultt of this prog gram was seen in the rreduction of the t budget defficit from 48, 110,000 Lekee in 1998, to 38,033,0000 Leke in 20010. This redu uction occurreed as a result of o cuts in personnel expenditures and goverrnment subsiidies. The Albanian government continued to implement otther programss from the Wo orld Bank and IMF, w which fosteredd further economic growthh and encourraged the regulation of the collectioon of taxes. Even thoough many prrograms were accessed, govvernment exp penditures exceeded revenues from 1998 to 2010.. Surprisingly, y, government revenues have increassed by almostt three times each year froom 93,519,000 0 Leke in 1998 to 3224,719,000 Leke L in 2010 0. In the sam ame way, government expendituress have increased each yearr but different ntly from reveenues; the expenses deecreased in thhe last year. In 1998, exppenditures weere about 141,628,0000 Leke, and after that theey experienceed a dramatiic rise to 362,752,0000 Leke in 20110. The budg get deficit shoowed its speedups and slowdowns several timess during the period. The highest budg get deficit occurred in 2009, whichh was about 80,005,000 L Leke as a result of an immediate iincrease in government ex xpenses. The lowest budg get deficit was markedd in 2005 at 288,176,000 Lek ke. Graph 12-1:: The trend off budget deficcit in Albania for the period d 1998 to 2010

Source: Minisstry of Finance

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Chapter Twelve T

Total revenues and a total expen nditures in Alban ania for the period 1998 to Graph 12-2: T 2010

Source: Minisstry of Finance

From thee other side, government expendituress have been the main concern of ffiscal policy in i order to maaintain stable growth. The two t main expendituress are current and a capital ex xpenditure. Thhe current exp penditures exceed morre than 80% % of total government g eexpenditures, and the remaining ppart is covered by capital expendituree and other expenses. e Current exppenditures havve passed thro ough an increaasing trend frrom 1998 to 2010. Trranslating to numbers, n in 1998 1 they weere 117,413,0 000 Leke, rising to 300,878,000 in 2010. In this group of exppenditures, th he highest percentage is represennted by social insurancee outlays, personnel p expenditure,, and interestt. For severall years, the ffiscal policy aimed at raising the wages and reducing th he personnel expenditure through reducing thee number of em mployees. On the other hand, capital expen nditure is diivided into tw wo main financing grroups: domestic financing and foreign ffinancing. Th he highest percentage iis covered byy domestic fin nancing, whicch exceeds more m than 60%. Considdering the tw wo last years, the t domestic ffinancing wass reduced from 75,6000,000 Leke in 2009, to 46,642,000 Leke in 20 010. This reduction is due to the decrease d in speending on eduucation, infraastructure, and health. Surprisingly, foreign financing in 2008 was more thaan double that in 20100. In 2008, forreign financin ng was 43,5877,000 Leke, decreasing to 20,850,000 Leke in 2010. 2 There was a suddeen increase of o foreign financing coompared to its amount in 20 007 of about 88,819,000 Lek ke.

W What are the Meaasures for the Best B Fiscal Policcy in Albania?

239

Graph 12-3: C Current expendditure and capital expenditure in Albania for the period 1998 to 2010

Source: Minisstry of Finance

Taax System in i Albania After the communism period, the Albanian A econoomy changed to a freemarket econnomy, which brought the privatisation p oof several centralisedgovernment property segments, s en ncouraged fooreign and domestic investment, and allowed the free moveement of goodds, people, an nd capital. The Albaniaan governmennt intervened to o increase ecoonomic growth h through tax changess, as this was the best way y possible forr generating revenues. r Currently, A Albania is usiing the flat-taax system, whhich is consid dered the lowest tax rrate in the reggion (Kadiu, 2012). 2 This fllat tax consistts of 10% for income and corporatte tax, and 20% for VAT tax. Since flat fl tax is presented as an equal trreatment of all a people, it has tried to decrease corruption, which is onne of the most m importannt problems in every developing country. By reducing tax x fraud, this system resullts in the increase off government revenues, in nvestment, ecconomic grow wth, and consumptionn. For examplle, the adaptio on of the flat tax in 2001 in i Russia, with 13% onn personal inccome, resulted d in a significaant tax revenue growth. The chaange of the Allbanian tax system in 2007 from a progreessive tax to 10% flat iincome tax enncouraged man ny people. Maany supporterrs thought that this taax system would w help th he economy by stimulating their investments. Another beenefit taken into consideeration was the t equal treatment of all people. But in this context, pooor people facced more discrimination because thhey were treatted like the ricch people. In this way, the income ddistribution frrom the rich to o the poor wass eliminated. As mentiioned above, taxes t are the main m source off government revenues and they cann be both dirrect and indireect taxes. Cusstom duties are one of

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the main inndirect taxes,, which sharp ply declined due to Worrld Trade Organisationn (WTO) meembership, CE EFTA, etc. Thhe rise of oth her taxes such as natioonal taxes, peersonal incomee tax, excise aand profit tax, and VAT and turnoveer tax resulted in tax revenu ue growth. Inddirect taxes like excise tax, custom duties, and VAT VA are the maain contributorrs to economic growth, and they alsso help in the growth of government tax revenues. Th hese taxes reached thee level of 50% % of total reevenue, whilee direct taxess such as personal inccome tax and profit p tax weree about 13.8% % in 2010. Graph 12-4: T The indirect taxxes in Albania for f the period 19998 to 2010

Source: Minisstry of Finance Graph 12-5: D Direct taxes in Albania A for the period 1998 too 2010

Source: Minisstry of Finance

What are the Measures for the Best Fiscal Policy in Albania?

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Is Albania Potential Place for Investment? Albania is a country that has shown a progressive increase in economic growth by considering the main fiscal and monetary policies. The progress made is shown by a sharp increase in GDP per capita from 1,452.50 USD in 1998 to 3288.40 USD in 2010. This positive economic shift was due to the replacement of the main industries by the investment field. It is necessary to mention that Albanian people used to work more in agricultural sectors and other industries before 1990. But the last decade has shown that people are more focused on domestic investment, by which they assure their monthly incomes. The graph below shows the net inflows of foreign direct investment (FDI) as measured as a percentage of GDP. It is obvious that the trend of FDI from 1998 to 2010 was positive, as it increased more than 5.6 times. During 1998 to 1999, it was difficult to have a positive impact on investment because of the 1997 war’s effects. However, after these years, FDI became one of the main contributors in GDP by increasing its levels year by year. The peak level was seen in 2010 when FDI consisted 9.36% of GDP; the lowest level was seen in 1999 at about 1.2% of GDP. It is important to mention that FDI was not affected by the crisis in 2008; on the contrary, it had the sharpest increase. Also, the total investment has shown a steep increase by approximately 9% from 2008 to 2010. The highest level is marked in 2008, 32.51% of GDP and its lowest level is in 1998 at about 16.91%. The graph shows a decrease during the last two years. This might have happened because of the crisis, but still total investments cover one-fourth of GDP. There are many other factors which stimulate further investment in Albania. The geographical position helps Albania to trade with many countries in Europe, the Balkans, and countries worldwide. Since it has different ways of transportation such as air, sea, and land, foreign investors from Greece and Italy decided to invest in Albania. The free movement of people, capital, goods, and services after 1990 has increased the importance of investment. This occurred because Albania applies a lower tax system as compared to other European countries, and it offers cheap labour costs.

Chapter Twelve T

242

The graph of FD DI and total inv vestments Graph 12-6: T

Source: Worldd Bank and IMF MF

R Regression Analysis In this ssection, the relationship will w be analyssed between GDP per capita and three independent variables: currentt expendituree, capital expenditure,, and VAT. Inn order to av void errors inn the interpreetation of regression, tthe independeent variables were w converteed from Lekee to USD. Through thee regression annalysis, the efffect of each inndependent vaariable on the dependeent one was identified. Thee results beloow are found by using Eviews proggram. Dependent V Variable: GDP PXCAPITA Method: Leaast Squares Date: 05/14//14 Time: 14::08 Sample: 19998 2010 Included observations: 133 Variable

C Coefficient

Std. S Error

tt-Statistic

Prob.

CURRENTE EXP

0.004051

0.003525 0

11.149058

0.2802

CAPITEXP

-00.003655

0.003294 0

--1.109569

0.2960

VAT

0.013287

0.008046 0

11.651352

0.1331

C

89991.067

2541.155 2

33.538181

0.0063

R-squared

0.976176

Mean M dependeent var

23615.77

Adjusted R--squared

0.968235

S.D. S dependennt var

5797.708

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S.E. of regression

1033.310

Akaike info criterion

16.96658

Sum squared resid

9609558.

Schwarz criterion

17.14041

Log likelihood

-106.2828

F-statistic

122.9249

Durbin-Watson stat

0.750091

Prob(F-statistic)

0.000000

From the Eviews Table, the regression line is Y = 8991.067 + 0.004X1 - 0.0037X2 + 0.0133X3. In the case where all three independent variables are equal to zero, X1 = 0, X2 = 0, X3 = 0, then GDP per capita is equal to the intercept value, Y = 8991.067. The predicted change in GDP per capita can be expressed as a function of the change in current expenditure: ǻY= 0.004*ǻX1. This means that with a one unit increase in current expenditure, ǻX1 = 1, the GDP per capita will increase by about 0.004. It is the same for the other two variables, where a one unit increase in capital expenditure, ǻX2 = 1, will decrease the GDP per capita by about 0.0037. While a one unit increase in VAT, ǻX2 = 1, will increase the GDP per capita by about 0.0133. The second part of this analysis is related to R-squared value. In this case, the R-squared is equal to 0.97, which means that 97% of the variation in GDP per capita for the sample with 13 observations is explained by independent variables. Less than 3% remained unexplained, which is a very low percentage to be considered. Considering the 5% significance level, all three independent variables are statistically significant since their t-statistics are greater than the significance level. So all independent variables should be part of the regression line, since they explain a very high percentage of GDP per capita variation and they are statistically significant.

Conclusions Albania has implemented the flat-tax system since 2007, which consists of 20% for consumption and 10% for income. This tax system treats all people the same way under the law, and it eliminates the distribution of incomes between the poor and the rich. However, it has helped in the increase of economic growth, and furthermore it encourages the decrease of fraud and corruption. Furthermore, the government has to intervene with more actions since the corruption level in Albania is significantly high. It is important to mention that investment plays a crucial role in the

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Albanian economy, and fortunately it has been an increasing trend each year. From the regression analysis, it is found that all independent variables are statistically significant, and they should be part of the regression line. In total, 97% of the GDP per capita variation is explained by current expenditure, capital expenditure, and VAT. The remaining 3% should be explained by incorporating other variables; regardless, the percentage is very low. In this case, the best measure of the fiscal policy is VAT since its t-statistics are higher as compared to the others. As a consequence, VAT being the best measure from the given fiscal indicators means that it has a greater effect on the economic growth.

References Blanchard, O., & Perotti, R. (1999). An empirical characterization of the dynamic effects of changes in government spending and taxes on output. Retrieved from http://www.nber.org/papers/w7269 Borensztein, E., De Gregorio, J., & Lee, J.-W. (1998). How does foreign direct investment affect economic growth. Journal of International Economics, 45(1), 115–135. Easterly, W., & Rebelo, S. (1993). Fiscal policy and economic growth: An Empirical Investigation, Retrieved from http://www.nber.org/papers/w4499 Hadjimichael, M. T., Dhaneshwar, G., Martin, M., Nord, R., & Ucer, E. M. (1995, Month Date). Sub-Saharan Africa: Growth, savings, and investment, 1986-93. Retrieved from https://www.imf.org/external/pubs/cat/longres.cfm?sk=439.0 Kadiu, F. (2012). Albania fiscal policy: Designing tax policy by given circumstances. Journal Name, 3(1). Page numbers. Knight, M., Loayza, N., & Villanueva, D. (1993). Testing the neoclassical theory of economic growth: A panel data approach. Retrieved from http://www.jstor.org/sTable/3867446?origin=pubexpor Krueger, A. O. (1979). Foreign trade regimes and economic development: Liberalization attempts and consequences. Journal of Development Economics, 6(3), 447–451. Landau, D. (1986). Government and economic growth in the less developed countries: An empirical study for 1960-1980. Economic Development and Cultural Change, 35(1), 35–75. Lee, J.-W. (1994). Capital goods imports and long-run growth.Retrieved from http://www.nber.org/papers/w4725 Mançellari, A. (2011). Macroeconomic effects of fiscal policy in Albania:

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A SVAR approach. Tirane: Bank of Albania. Otani, I., & Villanueva, D. (1990). Long-term growth in developing countries and its determinants: An empirical analysis. World Development, 18(6), 769–783. Shijaku, G., & Gjokuta, A. (2013). Fiscal policy and econnomic growth: The case of Albania. Tirane: Bank of Albania. Xhepa, S. (2000). Comparative analysis of tax systems with some countries of the region. Tirana: Bank of Albania.

CHAPTER THIRTEEN PEOPLE’S MOTIVES IN UTILIZING THE FREEDOM OF MOVEMENT WITHIN THE EU AS A RESULT OF VISA LIBERALIZATION POLICIES: CASE STUDY OF KOSOVO ALBAN ASLLANI, SHKUMBIN MISINI AND KUJTIM BYTYQI

Abstract: This study intends to identify, from a population sample, the main motives for travel of citizens from Kosovo to the EU Member States part of the Schengen Area, once the visa liberalisation takes place. The authors of this chapter take into account demographic information from the surveys handed out to citizens of Kosovo, and try to correlate them with their motives for travel to the EU. The study argues that visa liberalization for Kosovo is of imperative importance in preparing Kosovo for EU membership and other important international and EU integrations. The study also argues that citizens of Kosovo benefit substantially by creating networks with professionals in the areas of research, technology, and education. These networks could potentially lead to local businesses gaining from outsourcing, which would over time increase the economic development of the country. However, the study’s focal point is the analysis of the survey of Kosovars on how they would utilise the EU visa liberalisation regime, using descriptive, and correlation analysis. The descriptive statistics and Pearson correlation analysis show a strong negative correlation between employment status, and work and study as a reason for visiting the EU member states after visa liberalisation, while there is strong positive correlation between employment status and business, tourism and research as reasons for visiting the EU. Similarly,

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strong correlations have been found between the education level of the respondents and their age group on one side, and work, study, tourism, doing business, and conducting research as reasons for visiting the EU on the other side. By conducting such an analysis, the authors of this study expect to provide an overview of the current situation in terms of the economic and socio-political implications regarding the visa liberalization, and the motives of Kosovars in utilising the visa liberalisation regime as based on the responses received from the questionnaires. Finally, the study will offer some policy recommendations addressed to the government to best deal with such statistical results. Keywords: Visa liberalization, mobility, perceptions, motives for travel, policy responses

Introduction Visa Liberalisation for Kosovo refers to the right of the citizens of the Republic of Kosovoi to travel without visa requirement, or visa free, to the European Union (EU) member states included in the Schengen agreement area. Since the Thessaloniki agenda, which was announced on 16 June, 2003, the EU made a strong political commitment to the position that the countries of the Western Balkans should be considered for visa liberalisation with the hope of exploring possibilities of promoting peopleto-people contacts in the region (EU Council Conclusions, 2003). Following this, the EU has managed to ensure that a number of states have adopted the EU legislation in many key areas, while the majority of Western Balkan countries have enjoyed the visa-free establishment with the EU, and with particular emphasis on those countries that are part of the Schengen area (Asllani et al., 2013). Since 19 December, 2009, the citizens of Serbia, Montenegro and the Former Yugoslav Republic of Macedonia (FYROM), have enjoyed visa-free travel to the EU member states, in accordance with Regulation 539/2001 (EU Commission Report 2012). One of the immediate conditions for the citizens of the above countries to be able to travel visa-free within the EU member states was that they had to have biometric passports (Asllani et al., 2013). Under the same conditions, the citizens of Albania and Bosnia and Herzegovina (BH) have enjoyed the same visa-free travel to the EU member states since 15 December, 2010 (EU Commission Report, 2012). Economic and legislation reforms are necessary conditions that have to be met by all countries aspiring EU integrations according to the Copenhagen Criteria, which were created in June 1993, with the rules that

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define whether a country is eligible to join the European Union and further their reforms towards EU integrations (EU Commission Report 2012, Asllani et al., 2013). In order to begin the process and dialogue of European integrations, one country should meet the requirements under the roadmaps for the visa liberalisation dialogues. This is a process that was clearly defined in the visa liberalisation documentation set by the EU commission and the EU enlargement criteria. These roadmaps comprise guidelines regarding matters of document security, border management, asylum and migration, the fight against organised crime and corruption, and the protection of fundamental human rights. Countries wishing to further the process of European integration are expected to regulate and advance the country’s policies in these respective fields. By means of conditionality to enter the EU, the visa liberalisation process has proved to be vital in the Europeanisation process of the region, through the reform and regulations in the area of justice, freedom, and security (Kacarska, 2012). Countries that currently enjoy the visa-free regime have actively reformed their legislations, security policies, migration legislature, and have regulated the political relationships with countries in the region (Kacarska, 2012). Kosovo as well, would benefit from such a regime, both socially and economically (Asllani et al., 2013). Petrovic (2010) discusses the aspects of conditionality by focusing on the technical and political conditionality put forward to the Western Balkan countries in the early stages of the visa liberalisation process. Croatia worked in reforming the sectors of justice, migration and security before getting a visa-free regime with the EU, and then finally being admitted to the EU as a full member on the 1 July, 2013 (Petrovic, 2010). Currently, Kosovo is the only country in the region not to benefit from the visa liberalisation regime, as all of the countries in the region have benefited from such mobility. However, the European Commission launched a visa liberalisation dialogue with Kosovo on 19 January, 2012, and a roadmapii towards a visa-free regime was handed over to the government on 14 June, 2012. The EU commission report of 2013 addresses in detail the progress made by Kosovo in fulfilling the requirements of the visa liberalisation roadmap set out in the dialogue. One of the main points discussed in this report is the readmissions and reintegration of Kosovo citizens returning from EU member states. By analysing the visa-free regime and applying it in the case of Kosovo, this chapter intends to contribute to literature regarding the implications and impact of the visa-free regime of the Balkan countries. In what follows, we will give an overview of the existing literature, and

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research into the field of the visa-free regime for Kosovo. The focal point of the discussions and results analysis will be to understand the perceptions of people and their motives. Next, we turn to the methodology and the results of the data gathered for this contribution and scrutinise the enlargement strategies of the EU and Kosovo Government’s integration strategies, respectively.

Background on the EU visa liberalisation process Even though literature regarding visa liberation regimes in different parts of the world has expanded significantly over the years, there is a lack of detailed analysis and inquiry into public opinion with regards to the potential benefits and costs of citizen and resource mobility. Although there has been some research on public perception about the visa liberalisation regime with the EU from various reports published by different NGOs in Kosovo, there is still a lack of insight into the motives of Kosovo citizens to travel to countries of the EU (typically countries of the Schengen area), once the visa-free regime launches. This chapter analyses and evaluates the theory of visa-free regimes and their macroeconomic impacts, taking the regional countries as a basis and reference point for comparison into the inquiry of the socio-economic advantages, and costs, accompanying the liberalisation process. The right to free movement of persons has been anchored in European law and applies since the Treaty of Rome in 1957 (Hix, 2005). The removal of the barriers of movements and borders was first institutionalised with the Schengen Agreement in 1985, signed intergovernmentally between Benelux, France and Germany (Guild, 2009). Then, it was believed that the mobility of labour, people, and resources should be beneficial for the countries taking part. This approach is still considered valid and remains one of the main arguments put forward by different scholars when addressing the issue of visa-free regimes. Kacarska (2012) writes about the implications of visa-free regimes with the EU and the dialogues between the European Commission and national governments of the Western Balkan countries. The chapter concentrates on the Europeanisation of the Western Balkans through mobility, arguing that mobility can advance the countries through integration and socio-economic developments. The visa liberalisation regime affected the whole region in a positive way with Kosovo not being able to benefit from such a process yet. Even though Kosovo’s independence has been recognised by the majority of EU member states,

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Kosovo’s political state existence is still not recognised by five EU member statesiii. As per the roadmap, the Kosovo government will have to work hard to earn the EU’s approval in regard to the fulfilment of the benchmarks set out in the visa liberalisation roadmap (Group for Legal and Political Studies – GLPS, 2012). This can make it politically more difficult for Kosovo to pursue the visa liberalisation regime at the same pace as other Western Balkan countries. Similarly, the EU has its own stake in the process as well: it finds itself between the wheels of the lack of agreement on Kosovo’s status and security concerns, and of its desire to be a reliable international partner, inter alia, through a credible application of the principle of conditionality (GLPS, 2012). Even though Kosovo has made significant improvements in the areas of security and personal identity documents such as biometric passports, the holders of Kosovo passports can currently travel visa-free to only five states: Albania, Montenegro, FYROM, Turkey and Haiti. This makes Kosovo one of the most isolated countries in the region and perhaps in the world. In the absence of the roadmap from the EUiv, Kosovo’s government adopted their own Action Planv for reforming and implementing the roadmap of the visa liberalisation regime with the EU (Krasniqi, 2010; Ministry of European Integrations, 2012). The plan has integrated a roadmap based on the reforms and regional country policies which are to be implemented in order to unite EU integrations efforts. However, Kosovo recently received the roadmap for the visa-free regime from the EU and now faces the challenge of implementing the policies stated in that roadmap (EU Commission, 2013). In addition, civil society in Kosovo has significantly participated in the advocacy of visa liberalisation for Kosovo citizens. They have articulated their conviction that a visa-free regime with the member states of the EU is the only promising way forward for Kosovo to begin the process of Europeanisation and EU integrations, to protect minorities in Kosovo and to commence much needed reforms (GLPS, 2012). The report from GLPS (2012) in Kosovo also highlighted a number of comparative analyses of the visa liberalisation process in the Western Balkan countries and provided in detail the highlights of the differences between the Kosovo visa liberalisation roadmap and those of Western Balkans countries. In particular, the report highlights differences in the visa liberalisation roadmap given to Kosovo on the basis of improving the relations with neighbouring countries (with emphasis on the relations with Serbia), and the reforms that Kosovo needs to undertake with regards to the rights of minorities living in Kosovo. This was more applicable to Kosovo rather

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than to other neighbouring countries, and while other countries in the region have achieved their goals and been granted visa free regimes with the Schengen area countries, Kosovo’s status and negotiations with Serbia have been prolonging this process. For the Western Balkan counties that are now enjoying visa-free regimes with the EU, visa liberalisation did not come as a surprise. In fact, it was conditioned upon the countries performing substantial reforms in the field of migration and border control, public order and security, external relations and human rights, which the countries needed to put in line with EU standards (Chachipe, 2012). Similar to the conditions, Kosovo would have to prove such progress and reform capabilities. The report by Chachipe (2012) discusses in great detail the overall western Balkan approach to the admission of the visa liberation regime, but fails to discuss which steps Kosovo needs to undertake to be eligible for this process. Tavares (2012) writes about the economic aspects of European integration. Economic integration stems from the idea of a common base of policies associated with enforcing competition and facilitating the mobility of people and resources. Tavares (2012/13) argues that integration, and the mobility of peoples and resources between countries opens the way for new partnerships and relations between businesses and countries, as it can foster economic growth through trade, economic agreements, and partnerships. This would undoubtedly advance Kosovo as well: it will open doors to more business partnerships being created between businesses in Kosovo and elsewhere in the EU, and this would encourage economic growth and reduce unemployment in the country. The arguments of Tavares are extended to this Kosovo case study. Other countries in the region including the countries in the Eastern parts of the Balkans, have managed to benefit a great deal from visa liberalisation regimes. Albania, FYROM and Montenegro have gained in terms of increased trade with the EU and increased internal tourism in their countries (according to respective Ministries in these countries). Travel and tourism are one of the world’s most dynamic economic sectors, offering enormous opportunities for growth, development and job creation (UNWTO, 2012 and WTTC, 2012). Economic benefits of EU integration were truly understood in greater detail only after the establishment of the Single European Act in 1985 (Hix, 2005), which entailed the creation of the single market along with the removal of all internal physical barriers. At this time, the freedom of movement and the question of borders began to have tangible implications

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for the citizens of the EU. Integration naturally opens the way to a set of new partnerships and other relevant policies which could potentially lead to economic injections into a country (Dewatripont et al., 1996). The authors of this chapter believe that this is a significant argument, and Kosovo could benefit from the freedom of mobility of people and resources. As markets integrate the international political, regulatory, and legal institutions necessary to enforce market, openness and competitiveness become more important. In other words, the need for public goods provided at a “higher level” becomes evident (Casella and Feinstein, 1990). Market integration and institutional integration are complementary. The European founding member states seem to have understood this argument at a profound, intuitive level and have managed to significantly enlarge the market and labour mobility over the years (Tavares, 2012). The enlargement of the EU eastwards was seen to be important for the above factors as well. Indeed, East European countries that have joined the EU years ago have shown significant reforms in their economies, legislation, and in the fundamental rights for their citizens. Economic prosperity and reforms have become of imperative essence in the Kosovo situation. During 2012 and 2013, an increasing number of Kosovo citizens started to ask again for asylum in some of the EU member states with this constituting perhaps the biggest wave of people seeking asylum in the EU since after the war ended in 1999 (Gecaj, 2013). This should in theory act as a deterrent for Kosovo to be considered for the visa-free regime with the EU at this point in time. Even though statistics prove that an increasing number of Kosovo citizens are asking for asylum, active steps are being undertaken by the government to reduce this number in the form of readmission agreements with a number of EU countries (Ministry of EU Integrations, 2013). These regulations are expected to prevent future emigration from the country. Little to no research has been conducted into the perceptions of the Kosovo people with regards to the impact of the visa–free regime. Insufficient research was also done to understand people’s motives in travelling outside Kosovo in search for better living standards, education or employment. The following few paragraphs aim at filling this knowledge gap by offering some insight about what people think about the visa-free regime. From this, the chapter will also be able to draw conclusions on what the economic and social impact might be for Kosovo. Furthermore, this study aims to further the analysis presented by Asllani et al. (2013) by offering further correlation analysis between people’s

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motives and perceptions, and their reasons to travel to the EU member states. Such travel is not currently possible without a visa, but once the visa liberalisation takes place for Kosovo, it is anticipated that the interest and motives, as well as frequency of people to travel to the EU member states, will significantly increase, which could pose significant political risk for Kosovo in its political ambitions to join the EU in the future, and could potentially jeopardise the whole process of EU integrations, should the citizens be ill-informed regarding travel and their rights following the visa liberalisation. The subtle motive of this study is also to try to understand how well informed the citizens of Kosovo are regarding the visa liberalisation process (the sample part of the questionnaire), the rights to travel to the EU member states, and the rules and regulations regarding such travel once these very citizens benefit from the visa liberalisation.

Methodology As indicated above, the main purpose of this study is to obtain insight into the current development of the visa liberalisation dialogue for Kosovo by eliciting people’s perceptions about this process, and by analysing econometrically their motives for travel to the EU member states after the visa liberalisation for Kosovo is given by the EU Commission. Perceptions and people’s motives are predominately subjective, but they tend to offer adequate understanding and insight into the social, cultural and economic motives that drive Kosovo citizens to go to the EU member states. According to scholars in the field of research methodologies, such as Sekaran (2003), an exploratory and analytical study can be done when there is not much information about the subject, or even when there is no information available. Currently, there are not many statistical analysis regarding people’s motives in using their right to travel once Kosovo will be part of those countries that are benefiting from the visa liberalisation programme. Therefore, this study aims at gaining familiarity and a deeper understanding of the current situation, with regards to the visa liberalisation process for Kosovo, the perceptions of the population and the potential benefits, and costs, of such a process. We have conducted our research through a combination of qualitative and quantitative research methods. Moreover, this study is an in-depth extension of another paper published by the authors of this paper (Asllani et al., 2013). The qualitative part of the research consists of the analysis of the socio-economic factors to mainly help the conceptual part of our research, identifying research gaps and possible responses to those gaps, and then

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formalizing our arguments. A qualitative research method by contextualizing the data or historicizing it in the background of the relevant political, social and economic dimensions is used. The quantitative part of our research consists of the analysis of statistical data taken from the primary data from the questionnaires. For the purpose of this study, a random probability sampling was selected. According to Roscoe (1975), “sample sizes larger than 30 and less than 500 are appropriate for most of researches.” However, a representative sample size depends on the population, and this is why there is a sample size representative of the major municipalities in Kosovo. These major municipalities were selected for two reasons. One of the reasons is that these municipalities represent those municipalities with the largest populations in Kosovo, but also represent the largest youth populations. The second reason is that almost every household in these municipalities has a close family member or close relative living in an EU member state. The authors of this chapter will use the random probability sampling to conduct the analysis and produce a correlation analysis, in an attempt to link or correlate the respondents’ demographics with their motives and other responses in the questionnaires. The study will be looking at a number of correlative combinations, as the authors of this study believe that these will help the government, international community and other stakeholders to understand the real motives of people to travel to the EU member states after Kosovo benefits from visa liberalisation. The authors of this chapter anticipate that people are not very well informed about the rules and regulations concerning visa liberalisation for Kosovo, (Asllani et al., 2013), and therefore intend to highlight a number of issues that the government of Kosovo should be concerned about; at the same time the authors of this study will try to present a number of recommendations for the government to try to tackle these issues, so that the visa liberalisation process and its implementation is in accordance with the timeframe and regulations set out by the European Commission. A questionnaire was prepared to record people’s responses and later analyse their motives using econometric techniques. In these randomly distributed questionnaires, people were asked for their contribution by selecting the option of the answer for which they believed it to be the case, or the situation in general, or selected an answer in which they believed that it represented their perceptions, motives, demographics and analysis. The questionnaires were distributed randomly on the streets, in the shopping centres, universities, libraries, cafeterias and bars of the five largest regional centres in Kosovo, which include Pristina, Ferizaj, Prizren,

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Gjakova and Gjilan, as well as other municipal districts of these regional centres, such as Vitia, Shtime, Kacanik, Hani i Elezit, Lipjan, Decan, Suhareka, Dragash, Fushe Kosova, Rohovec and Podujevo. These municipalities and the regional centres represent the largest population concentration in Kosovo. Two other regional centres and their municipalities (Peja and Mitrovica), which also represent larger populations in Kosovo, are not represented in this study. .

The age of the respondents was the main factor to determine and limit the distribution of the questionnaire. We purposefully restricted our respondents to the age category of 16 years or older. The reasons for this age constraint relates to the right to travel without assistance outside the country. The other determinant and limitation for the questionnaire distribution was the limited number of questionnaires distributed to professionals currently working in Kosovo and earning more than 1,500 Euros monthly and those that were working for the local, regional or central governmental institutions, or that were politically engaged. The authors of this study believed that people’s very high salaries, active political engagement with a political party or working for a governmental institution could skew the results and make them biased. In total, 958 people responded to the questionnaires. Through the questionnaire it was desired to determine what the respondents would most want to do once the visa-free regime takes place with the EU, in an attempt to try and understand the purpose of their visit. In other words, it was intended to analyse people’s motives in utilising the freedom of movement within the EU, and in particular the Schengen area. This served as a basis for the analysis to offer sound conclusions relating to the research topic. The questionnaire consisted of a total of 20 multiple choice questions and was divided into two parts. Part one consisted of demographic enquiries regarding the age group, gender, level of education and their employment status. Part two turned to the perceptions of the visa liberalisation process in Kosovo and the respondents’ motives for going to the EU. As such, it was intended to link the social demographic factors of the respondents with the rationale behind their perceptions and motives, and presented, as well as analysed, the descriptive statistical results below. The descriptive and correlation statistical results were generated using IBM SPSS and MS Excel, were analysed and served as the basis for the analysis and evaluation. The correlation analysis was evaluated using econometric techniques for age, gender, employment and marital status, education level, profession, and the optimism of the respondents with regards to Kosovo’s EU integration process on one side, and their

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responses to their motives and reasons for travel to the EU member states, the impacts and the benefits of the visa liberalisation for the respondents individually and for the country, on the other.

Main Body - Results and Discussions 958 completed questionnaires were analysed and some interesting results have been found regarding the perceptions of the citizens of Kosovo towards visa liberalisation with the EU, or their motives for utilising the freedom of movement within the EU. In some of the questions in the questionnaire, the respondents had the option to select two, three or four options. In order to provide some analysis for the study it is important to highlight some descriptive statistical percentages of the random population sample and their demographics. This is important since the study will use correlation analysis of the respondent’s demographics and their motives for travelling to the EU member states. Of the 958 respondents who took part in our research, 52% were male, 48% were females. Of those, 64.5% were single, 33.6% were married, with the remaining percentage of 1.9% being divorced. The majority of our respondents were aged between 21 to 30 years of age, followed by below 21 years of age, and 31 to 40 years of age, with percentages given in Table 13-1. The official government statistics, as well as our sample of statistics signifies that the majority of population in Kosovo is between the ages of 15 and 30. Our sample reveals that almost 45% of our respondents were unemployed, while 13.4% were earning a monthly salary of between 251 and 350 Euros and 11.7% were earning a salary of between 351 and 450 Euros. This corresponds with the current employment and unemployment structure of Kosovo. According to ASK (2012), the unemployment figures in Kosovo amount to 30.9% in general and 55.3% among youth aged 15 to 24. The higher unemployment rate can be reasoned with the age of our respondents, where the majority of our respondents were aged between 21 and 30, and as such the rate of unemployment from our data sample exceeds 44%, as indicated in Table 13-2 below. Also, according to ASK (2012), the unemployment rate for males and females is 28.1% and 40.0%, respectively. Table 13-3 shows the unemployment figures of the population sample according to their gender and marital status, which approximate the current employment and unemployment structure of Kosovo.

People’s Motives in Utilizing the Freedom of Movement

Table 13-1: Statistical description of population sample % as of population sample Gender

Marital Status

Age

Male

51.6%

Female

48.4%

Single

64.5%

Married

33.6%

Divorced

1.9%

Below 21

28.8%

21 to 30

41.3%

31 to 40

16.9%

41 to 50

8.6%

Above 50

4.4%

Table 13-2: Employment status and monthly salaries in Euros % as of population sample Unemployed Below 250

44.8% 7.9%

Between 251 and 350

13.4%

Between 351 and 450

11.7%

Between 451 and 550

6.9%

Between 551 and 650

3.1%

Between 651 and 750

1.9%

Between 751 and 999

0.8%

Over 1000

0.8%

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Table 13-3: Employment structure of the population sample in Euros Male

Female

Single

Married

Divorced

Unemployed

42.5%

47.2%

67.0%

14.9%

0.0%

Below 250

11.7%

3.9%

10.0%

4.7%

44.4%

Between 251 and 350

15.4%

11.3%

11.3%

23.6%

11.1%

Between 351 and 450

10.9%

12.6%

5.2%

29.1%

22.2%

Between 451 and 550

9.3%

4.3%

2.6%

15.5%

11.1%

Between 551 and 650

4.5%

1.7%

1.3%

6.8%

11.1%

Between 651 and 750

2.8%

0.9%

1.0%

3.4%

0.0%

Between 751 and 999

1.2%

0.4%

0.6%

1.4%

0.0%

Over 1000

1.6%

0.0%

1.0%

0.7%

0.0%

In search of better education and career opportunities, as well as finding jobs, many of the youth that participated in our questionnaires are convinced that they would be able to find jobs and a place of study in the EU, once the visa liberalisation regime takes place. It was surprising to see in the results that a majority of the population sample did not have enough information regarding the rules and regulations of the visa liberalisation and travels under those provisions. Data reveals that people selected reasons such as work and study in the EU member states as one of their motives for travel; both of which are not possible under the regulations of the visa liberalisation arrangements with the EU. Under such provisions people are allowed to travel to the Schengen area countries without a visa provided that they do not exceed 90 days of stay in those countries and that they do not engage in any paid work or activity, nor are they allowed to study for a degree or such. They are allowed, however, to participate in student exchanges, and language or other professional courses, as long as they do not exceed 90 days at a time, or if they get a clearance to stay more. As the statistics highlight below, the main reasons that people would travel to the EU member states after visa liberalisation would be for education, work and tourism purposes. However, as stated above with the visa liberalisation regime, people would not be able to work in the EU

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259

member states, nor would they be able to study without a specific clearance. The majority of people are not aware of this, and those that are aware are planning on finding seasonal jobs in the EU member states, in an attempt to send money back home to their families. According to ASK (2012), which are official government statistics, general poverty exceeds 29% in Kosovo, and extreme poverty is around 10.2%. This could explain why some people would risk being deported and expelled, or refused future entry or travel for a good number of years, to a particular EU member state part of the Schengen area, if caught working. The poverty as a result of high unemployment and lack of opportunities could motivate people to travel around the Schengen area in search of better opportunities and work, even if they know that they are not allowed to do engage in any paid employment. As shown in the Table below, men are more drawn to the opportunity of finding work then women, with 25% and 23% respectively, of respondents selecting that as their main reason for travelling to the EU member states part of the Schengen area. On the other hand, women are more drawn to the idea of finding a place of study as the main reason for travel, with 29% and 42% for men and women, respectively. Table 13-4: Motives of people traveling to EU member state part of the Schengen area Reason

Reason

Reason Tourism

Reason Business

Reason Research

Work

Study

Male

25%

29%

23%

18%

5%

Female

23%

42%

25%

7%

3%

Total (avg.)

24%

35%

24%

13%

4%

In the questionnaire, respondents were asked to select two reasons for going to the EU after the visa liberalisation for Kosovo is granted. As the Table below (13-4) shows, around 35% indicated that they would want to go to EU for studying, while 24% selected work as the reason for the visit, while around 24%, 13%, and 4% chose tourism, business or research, respectively. ‘Family visits’ were purposefully not provided as one of the options, since almost all households in Kosovo have relatives living in the EU, and as such that would have been an obvious reason for all respondents to select: the questionnaire wanted to determine their

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responses for the below reasons only. Our data analysis also reveals significant correlations between the age, level of education, monthly salary, marital status and gender on one hand, and the reasons why the respondents would want to visit the EU member states part of the Schengen Area, on the other hand, as shown below in Table 13-5. These correlations have been calculated using SPSS and are 2tailed Pearson Correlation analysis. Table 13-5: Correlation analysis on motives Reason: Work

Reason: Study

Reason: Tourism

Reason: Business

Reason: Research

-.966**

-.710*

0.42

.734*

.915**

0

0.032

0.261

0.024

0.001

-0.632

.742*

.768*

-0.365

.839**

0.068

0.022

0.016

0.334

0.005

-0.571

-.916*

.992**

0.755

0.193

Sig. (2tailed)

0.315

0.029

0.001

0.14

0.756

Pearson Correlation

.734*

-.716*

0.858

0.455

0.186

Sig. (2tailed)

0.021

0.029

0.015

0.272

0.788

-0.275

.922**

.992**

-0.735*

-.712*

0.532

0.021

0.001

0.135

0.028

Employment status /Salary

Pearson Correlation

Education Level

Pearson Correlation

Sig. (2tailed)

Sig. (2tailed) Age Group

Marital Status

Gender

Pearson Correlation

Pearson Correlation Sig. (2tailed)

Note: **. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed).

The analysis of the results reveal that there is significant negative correlation at both the 0.05 level and 0.01 significance levels between employment status/monthly salary and work as reason or motive for going

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261

to the EU member states after visa liberalisation. This shows that people were more likely to select work as a motive or reason for travel if they were unemployed or if they were earning a very low monthly salary. The higher the salary that one employee had, the less likely it was that he or she selected work as a motive for travel to the EU member states part of the Schengen area. Similarly, there was a negative correlation between the motive of study and employment status or monthly salary. People taking part in the questionnaires that were earning higher salaries, or had full time employment, were less likely to select Study as the reason or motive for travel, while those that were unemployed or earning very low salaries (who on most of the occasions were students) were more drawn to the motive of furthering their education in an EU country. The data also revealed negative correlations at both significance levels between the age group of the respondents and their level of education. The higher the level of education of a respondent was, the less likely that work was selected as a reason for a visit to the EU member states after visa liberalisation is approved from the EU Commission for Kosovo. Similarly, the higher the age group that the respondent belonged to, the less likely that work or study was selected. One would expect this to be the case, as older people are less likely to further their studies, and the more educated a person is the more likely they would be to further their studies in a prominent university in the EU. A positive significant correlation can be found in reasons other than work and/or study. When the respondent is older and/or educationally well-qualified, they would be more likely to visit EU member states for reasons such as tourism, business and research. Clearly they have motives for such visits as some of the people who took part in the questionnaires were business owners, and as such their motive for travelling for business purposes is explainable. Some other respondents were lecturers, and others were professionals, and their motives for research are also intuitive. Conversely, when the respondent belonged to a younger age group, they were less likely to select reasons of tourism, business and research for travelling to the EU member states. It is also worth mentioning the correlations between marital status and gender on one hand, and reasons or motives for travel on the other hand. As the results above indicate, there is a significant negative correlation at the 0.05 significance level between marital status and study for going to the EU. This could be explained in that the majority of the married respondents, were either employed or already well qualified, and as such tended to select another reason for travel other than study. The respondents

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who were single were more likely to select the reason of Study. Similarly, there was a negative correlation at the 0.05 significance level between the gender of the respondent and their motives for going to EU for business or research. More men than women selected business or research as the main motive for travelling to the EU. It is also important to note the level of education amongst the 958 respondents. The majority of our respondents had graduated from high school and held a college diploma or university degree. One of the questionnaire’s main aims was to determine what the youth’s responses would be in relation to visa liberalisation and to try to analyse their motives for travel to the EU member states once allowed to freely do so under the visa liberalisation conditions. As such, the majority of the youth who took part in the study were in the abovementioned education categories. The correlation between the level of education and work/business as reasons for going to the EU member states is a negative one and it is also significant at the 0.05 significance level. The higher the respondent’s level of education, the less likely they are to go to the EU for work or business. From the respondents, 44.85% had higher education qualifications (university degree, Master’s degree and PhD) of which 83.13% chose other reasons than work for travelling to the EU member states, such as tourism, research, and study. This again shows the clear correlation between education level and reasons for travelling to the EU member states. The results also indicate that 41.34% were graduates or students from colleges. Table 13-6: Education of the respondents as a % of population sample % as of population sample Male

Female

Total

No Education

0.21%

0.00%

0.21%

Religious Education

0.21%

0.00%

0.21%

Primary School

0.85%

0.43%

1.28%

23.17%

18.17%

41.34%

High School

7.01%

4.25%

11.26%

Licensed Professional

0.64%

0.21%

0.85%

26.46%

12.65%

39.11%

Master’s Degree

3.61%

1.49%

5.10%

PhD

0.21%

0.43%

0.64%

College

University Degree

People’s Motives in Utilizing the Freedom of Movement

263

Part of the questionnaire had questions about the benefits, impact and optimism of the citizens with regards to the visa liberalisation process for Kosovo. The tables below highlight some statistics generated from the responses of the sample population. Table 13-6 highlights some statistics regarding networking reasons and the profession of the respondents who took part in the questionnaire. Economic integration, in particular the mobility of people and resources, or the freedom of movement between countries, opens up the way to set up new partnerships and relations between businesses and countries. The freedom of movement can foster economic growth through trade agreements, networking and partnerships (Tavares, 2012 and Tavares, 2013), with this benefiting Kosovo in the mid and long run. Additionally, it will open doors to more business partnerships being created between businesses in Kosovo and elsewhere in the EU, and this would encourage economic growth and reduce unemployment indirectly in the country (Asllani et al, 2013). The results analysed from the questionnaire also support this argument. A majority of the respondents, who would visit EU member states once visa liberalisation takes place, will be visiting Europe for possibilities to network, as one of their main motives. Results in the Table below indicate some of the reasons why the respondents would be travelling to the EU member states once the visa liberalisation process is completed. This is likely to result positively in creating business partnerships and opening up new markets for businesses engaging in trade between EU and Kosovo. This could also result in technological and know-how expertise being transferred to Kosovo, which would help towards the development of the country. Networking for business opportunities could also benefit Kosovo in terms of increasing the number of cost-driven firms who would want to outsource their production to lower cost countries. There are a number of firms that currently utilise Kosovo as an outsourcing destination. Firms that have outsourced their production and services to Kosovo range from various sectors, but most typically include call centres, IT start-ups, programming and IT development companies, accounting and auditing firms, car part manufacturers, etc (Asllani et al, 2013).

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Table 13-7: Networking reasons and profession of the respondents Networking reasons

% as of population sample

Networking for Study

22.54%

Networking for Career Development

22.36%

Networking for Exports and Imports

11.71%

Networking for Innovation

5.07%

Professional Experience

24.76%

Networking for Business Contracts

13.55%

Profession of respondents

% as of population sample

Businessperson

6.27%

Teacher/Lecturer

12.98%

Student/Work Experience/In Education

33.66%

Admin/ IT/Manager/Other

6.49%

Lawyer/Economist

5.17%

Technician/Mechanic/Engineer/Construction

4.40%

Security/Police/Army

6.05%

Services/Waiter/Chef/Taxi

8.25%

Salesperson/Agent

8.03%

Doctor/Nurse/Chemist/Scientist

8.69%

Table 13-8 below shows the results of the respondents’ perceptions concerning the benefits to be had from visa liberalisation for Kosovo. The results are spread almost evenly between the available categories, however, there is a greater perception amongst the respondents that with visa liberalisation they would benefit in terms of more alternatives for products and services, better quality of goods coming from the EU member states, and greater access to technologies and, possibly cheaper, white goods. They believe that they would have such benefits as a result of that freedom of movement and the ability of people to engage in different business contracts and networks with companies operating in the EU,

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under strict quality and standard regulations set out by the EU. Such perceptions are taken further to indicate that this could incentivise local producers and businesses to maintain high standards and qualities in their product and service offerings in order to compete with competition from the EU. Table 13-8: Respondents’ benefits of visa liberalisation Benefits of Visa Liberalisation

% as of population sample

Quality of Goods

20.3%

Lower Prices for Goods

15.3%

More Choice of Goods

21.9%

Access to Technology and White Goods

17.9%

Changes in Rreferences for Regional Goods

12.1%

Changes in Rreferences for Local Goods

12.5%

The Table shown below shows the respondents’ optimism for Kosovo being accepted under the visa liberalisation regime within the Schengen area and correlation with their motives for travel to those countries under the principles of the visa liberalisation agreement or settlement. Table 13-9: Respondents’ optimism and correlation with their motives Visa Liberalisation Optimism

Reason Work

Reason Study

Reason Touris m

Reason Busine ss

Reason Resear ch

Within 1 year

15.5%

19.0%

37.9%

23.4%

14.7%

5.0%

Within 2 years

38.4%

23.8%

35.2%

24.8%

12.1%

4.2%

Within 5 years

46.1%

28.4%

34.0%

22.6%

11.6%

3.5%

100.0%

24.4%

34.7%

22.9%

13.8%

4.3%

Total (avg.)

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The results above show that the majority of the 958 respondents believe that Kosovo will benefit from visa liberalisation within one or two years (15.5% plus 38.4%), while the others who tended to be pessimistic about the process of visa liberalisation for Kosovo (more than 46%), believe that it will take as many as five years for such a process to be finalised. Their pessimism is linked with their employment status as the unemployed tend to be pessimistic about the future and do not believe in the current governmental capacity to further the reforms needed for Kosovo to benefit from such a process. Of the same mindset are those whose salaries are low as well. It is worth noting that those that are less optimistic, are more likely to select work and study as their main motives for travel to the EU, while those that are earning more than 400 Euros per month, seem to be more optimistic about the achievements of the reforms needed for visa liberalisation within one or two years at the most, and they are less likely to have selected work as the main motive for travelling to the EU. Therefore, there is a strong correlation between optimism and reasons or motives for travel to the EU member states part of the Schengen area. According to the results indicated above in Table 13-8, can be said that, the more optimistic the respondents were about the process of visa liberalisation for Kosovo, the more likely they were to select reasons other than work, as their main motives for travel. Conversely, the less optimistic the respondents were, the more likely they were to select work as the main reason and less likely to select the other motives or reasons for travel. This could also potentially show that 46.1% of the respondents did not have adequate information regarding the whole process of visa liberalisation with Kosovo and the rules of such a process.

Conclusions In this study, the perceptions and motives of people of Kosovo (across major towns and municipalities) have been analysed concerning visa liberalisation conditions, and their motives for travel to the EU. The study was initiated by providing a general overview of visa liberalisation, with specific attention to the region. Such a process for the region and Kosovo in particular, is understood to be a process of conditionality in which countries achieve a number of reforms before they benefit from the visa liberalisation process. By means of conditionality to enter the EU, the visa liberalisation process has proved to be vital in the Europeanisation process of the region through reform and regulations in the area of justice, freedom, and security. This is proving to be the case for Kosovo as well. The social and economic aspects of visa liberalisation have been

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analysed within the analysis part of the study, with the main aim of filling the literature gap in Kosovo related to this field. The analysis of the data resulted in interesting observations and interpretations regarding the relationship between the demographic factors and people’s motives to travel to the EU, and their perceptions of the visa liberalisation regime. These and other statistics could contribute to help understand why people are leaving Kosovo even before visa liberalisation approval, and could help the government to shape their strategy for action. The government should be urgently acting to provide more information to the citizens of Kosovo about their rights to travel under the visa liberalisation process and inform the citizens about other conditions that need to be met. An extensive media campaign should be run on national televisions and newspapers in an attempt to inform citizens of their rights for travelling to the EU member states as part of the Schengen area. From the analysis, and the results on people’s perceptions and motives, this chapter can conclude that the government has to speed up the reforming process according to the roadmap. The roadmap and the dialogue with the EU will undoubtedly benefit Kosovo in reaching European standards in regards to legislation, the freedom of movement, the fundamental rights of all citizens, including minorities living in Kosovo, and the realisation of other reforms which could contribute towards the economic development of Kosovo. Reforms in legislation and other areas would be speeded by the government in order to qualify for the visa liberalisation and eventual EU integration, which would not have been otherwise, or would have taken longer for the reforms to take place. The visa liberalisation process and the conditionality specified in the roadmap is essentially acting as the carrot that Kosovo is chasing towards, and this is speeding the reform process for the benefit of Kosovo citizens. As has been evaluated above in the study, the benefits of visa liberalisation for Kosovo are significant. The starting argument is that the countries in the immediate region have contributed significantly from such the freedom of mobility of people and resources. The benefits of visa liberalisation are both social and economical in nature. The freedom of movement of people is likely to attract investments in the country which could benefit the economy and economic development. It is likely that Kosovo will benefit in areas such as outsourcing, potential increases in inward FDI, creating business links with business in the EU, and as such increasing the level of exports and stabilising the balance of payments. The social benefits can be argued in terms of the contact theory and that the visa liberalization will strengthen the process of transition and

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development of democracy for all in Kosovo, including minorities. Kosovo’s isolation as the only country in the Western Balkans not to benefit from visa liberalisation has created pessimism in the country, and many young and the unemployed have recently tried to illegally enter EU member states and claim asylum, but ended up in camps in Hungary and other countries. This pessimism is evident in the analysis of the respondents’ motives and perceptions on the visa liberalisation process. Visa liberalisation with the EU would create mobility, and as a result of mobility and a visa-free regime, citizens could benefit from cultural exchanges that facilitate the interaction between communities and visitors (domestic and international). People want to interact with other cultures and learn about traditions, and even challenge themselves with new perspectives on life and society. This is also evident regarding people’s motives for travelling to the EU member states, as a majority of them want to visit the EU for reasons of tourism and study with this contributing to a more politically and socially stable region. On the other hand, at this stage in Kosovo’s transition and development, one could argue that there could potentially be negative impacts as a result of visa liberalisation for Kosovo. It has been analysed that negative impacts may arise as a result of increased competition for local businesses, imported inflation, the possibility of ‘exporting’ talent abroad, and the fear that citizens would start working illegally in EU member states. This argument can be supported with the results gathered from the questionnaires, in which a large percentage of the respondents’ age 30 or less, and more evidently below 25, have selected or indicated that their main motive for travelling to the EU would be in search of work. This is likely to affect the image of Kosovo as a country trying to reform itself, and it is likely to prolong the whole EU integration process. Although visa liberalization promises visa-free movement in the Schengen area, according to a number of NGOs in the country (as discussed above), it is believed that about 10 per cent of the Kosovo population will benefit from it – and they are those who have the financial means to travel, and those who are already travelling to the EU for tourism and/or business related activities. While the majority of population mobility is limited by economic and financial situations, which means that if you do not have enough financial means to prove that you can pay yourself throughout your stay for accommodation, health insurance and others, then under Article 5.1 of the Schengen Borders Code, travelling to the Schengen area will not be allowed. However, the majority of respondents in the randomly distributed questionnaire do not see visa

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liberalization as an opportunity to move freely as tourists or visiting relatives, but also as an opportunity to work and to change their, already difficult, social and economic situation. The decisions to grant visa-free travel to citizens of the Western Balkan countries, including the citizens of Kosovo, are based on thorough assessment of the progress made in the areas identified in the roadmaps from the visa liberalisation dialogues. The visa-free regime is perhaps the most tangible benefit for the Western Balkan countries in the process of their integration into the EU. European Union integration, and in particular visa-free regimes, are very strong incentives for accelerating reforms in the area of justice and domestic affairs, which could potentially lead to economic reforms. Having analysed in detail the correlations of the respondents’ motives for travel, and the positive and negative impacts of the visa liberalisation process for Kosovo, as well as having analysed the process of visa liberalisation in the region and the conditionality mechanism for Kosovo and the region to benefit from such free movement arrangement within the Schengen area, the authors of this study believe that the whole process could contribute towards the betterment of society and a more accelerated economic development for the country, which could take Kosovo closer to EU integration and a more politically stabilised region.

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http://www.bidnetwork.org/en/plan/344006. Last accessed 29th March2014. Bigo, D. (2009). Immigration Controls and Free Movement in Europe. International Review of the Red Cross. 91 (No. 875), p579-591. Bigo, D. & Guild, E. (2005). Controlling frontiers: Free movement into and within Europe. Aldershot: Ashgate Casella, A. (1992). On markets and clubs: Economic and political integration of regions with unequal productivity. American Economic Review, Papers and Proceedings. Casella, A. & Feinstein, J.S. (1990). Public goods in trade: On the formation of markets and political jurisdictions. Working Paper in Economics E-92-12, The Hoover Institution, Stanford University, May. Dahl, R.A. Chachipe. (2012). Selective Freedom - The Visa Liberalization and Rest restrictions on the Right to Travel in the Balkans. Available: http://romarights.files.wordpress.com/2012/07/chachipe_visa_liberalis ation_report_270612.pdf. Last accessed 11th May 2014. Dewatripont, M. & Ginsburgh, V. (1994). European Economic Integration a Challenge in a Changing World. Contributions to Economic Analysis v. 224: Elsevier Science Ltd. Dewatripont, M., F. Giavazzi, J. von Hagen, I. Harden, T. Persson, G. Roland, H. Rosenthal, A. Sapir & G. Tabellini (1996). Flexible Integration: Towards a More Effective and Democratic Europe. London: CEPR, London. Dalipi, L. (2011). Let's Outsource in Kosovo. The Horizon - American Chamber of Commerce in Kosovo. July 2011, p10-12. European Commission. (2013). First Progress report on the implementation of the Commission Staff Working Paper "Pollutant emission reduction from maritime transport and the Sustainable Waterborne Transport Toolbox". Available: http://ec.europa.eu/commission_2010-2014/kallas/headlines/news/20 13/06/doc/com(2013)475_en.pdfhttp://ec.europa.eu/commission_20102014/kallas/headlines/news/2013/06/doc/com(2013)475_en.pdf. Last accessed 7th May 2014. European Commission. (2012). Third Report on the Post-Visa Liberalisation Monitoring for the Western Balkan Countries in accordance with the Commission Statement of 8 November 2010.Available: http://eur-lex.europa.eu/ LexUriServ/LexUriServ.do?uri=COM:2012:0472:FIN:EN:PDF. Last accessed 19th April 2014. European Stability Initiative. (2013). A visa roadmap for Kosovo.

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Available: http://www.esiweb.org/index.php?lang=en&id=444. Last accessed 29th April 2014. European Movement in Albania (EMA). (2010). Monitoring the Visa Liberalisation Process with Albania: What to expect when you are expecting?. European Movement in Albania (EMA). May 2010 (Policy Paper), p3-21. European Union Office in Kosovo. (2012). Visa Liberalisation With Kosovo Roadmap. Available: http://eeas.europa.eu/delegations/kosovo/documents/eu_travel/visa_lib eralisation_with_kosovo_roadmap.pdf. Last accessed 6th May 2014. Gecaj, K. (2013). Varfëria, të rinjtë po ikin. Available: http://zeri.info/artikulli/5301/varferia-te-rinjte-po-ikin. Last accessed 9th May 2014. Gjokutaj, E. & Hroni, E. (2013). Stories behind Visa Liberalization: Asylum Seekers and Irregular Migration. Available: http://idmalbania.org/sites/default/files/publications/liberalizimi_i_viza ve_-_english_v3.pdf. Last accessed 20th April 2014. Group for Legal and Political Studies (GLPS) (Andrea Garaiova Albana Merja). (2022). Kosovo and Visa-free travel regime: The increasing EU Member States’ scepticism and regional experiences. Available: http://legalpoliticalstudies.org/download/Policy%20Report%2005%20 2012%20eng.pdf. Last accessed 5th May 2014. Hix, S. (2005). The political system of the European Union, Macmillan, London, 2nd Edition Kacarska, S. (2012). Europeanization through mobility: Visa liberalization and citizenship regimes in the Western Balkans. CITSEE Working Papers (The Europeanisation of Citizenship in the Successor States of the Former Yugoslavia). 2012/12 (12), p3-33. Kawulich B. (2005). Participant Observation as a Data Collection Method. Available: http://www.qualitative-research.net/index.php/fqs/article/view/466/ 996. Last accessed 20th April2014. Kosovo Agency of Statistics (ASK). (2011). Census 2011. Available: http://esk.rks-gov.net/eng/. Last accessed 12th May 2014. Ministry of European Integrations, Kosovo. (2012). Action Plan on negotiation of the Stabilisation and Association Agreement. Available: http://www.mei-ks.net/repository/docs/Anglisht.pdf. Last accessed 10th May 2014. Ministry of Foreign Affairs of the Republic of Kosovo. (2012). Republic of Kosovo. Available: http://www.mfa-ks.net/?page=2,121. Last accessed 11th May 2014.

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Ministry of Foreign Affairs of the Republic of Kosovo. (2012). Visas for Kosovo citizens. Available: http://www.mfa-ks.net/?page=2,70. Last accessed 9th May 2014. Petrovic M. (2010/04). Freedom of movement in the European Union: Visa liberalisation in the Western Balkan countries. LSE Migration Studies Unit Working Papers. No. 2010/04 (No. 2010/04), p1-44. Pettigrew, T. F. (1998). Intergroup Contact Theory. Available: http://www.students.uni-marburg.de/~Nauj/downloads/03. %20Semester/expra/annurev.psych.49.1.65.pdf. Last accessed 28th April 2014. Redaksia. (2013). Varfëria shtyn të rinjtë të largohen nga Kosova. Available: http://tung.ch/varferia-shtyn-te-rinjte-te-largohen-nga-kosova/. Last accessed 29th Jul 2013. Sekaran, U. (2003). Research methods for business: A skill building approach. 4th ed. New Jersey: John Wiley & Sons. p20-31, p48-64. Tavares, J. (2012). On the Future of European Integration: Ideas, Economics and Political Economy . Dahrendorf Symposia Series. 2012-13 (2012-13), p1-13. Tabak, N. (2010). IT outsourcing to Eastern Europe on the rise. Available: http://www.dw.de/it-outsourcing-to-eastern-europe-on-the-rise/a6347794. Last accessed 9th May 2014. World Tourism Organisation (UNWTO) and World Travel & Tourism Council (WTTC). (2012). The Impact of Visa Facilitation on Job Creation in the G20 Economies. Available: http://www.wttc.org/site_media/uploads/downloads/Visa_facilitation.p df. Last accessed 29th April 2014.

Notes i

"This designation is without prejudice to positions on status, and is in line with UNSCR 1244 and the ICJ Opinion on the Kosovo Declaration of Independence." Only ‘Kosovo’ will be used in the following pages. The ‘Kosovo*’ should be implied throughout. ii

European Union Office in Kosovo. (2012). Visa LiberalisationWith Kosovo Roadmap.

iii

Website of the Ministry of Foreign Affairs in Kosovo - consulted on 20.04.2014

iv

European Union Office in Kosovo. (2012). Visa Liberalization With Kosovo Roadmap. v

Action Plan was Implemented initially in 2010, and then extended with greater

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details in 2012 by the Ministry of European Integrations of Kosovo. Ministry of European Integrations, Kosovo.(2012). Action Plan on negotiation of the Stabilisation and Association Agreement.

CHAPTER FOURTEEN THE IMPACT OF PUBLIC AND PRIVATE TOURISM INVESTMENTS ON TOURISM PERFORMANCE AND GDP: CASE STUDY OF BALKAN COUNTRIES KEMAL KANTARCI, MUSTAFA ÜNVER AND KAZIM DEVELIOöLU

Abstract: The main purpose of this study is to uncover the effects of both public and private investments on tourism performance and gross domestic product in the Balkan countries. In order to examine this effect, we used the World Tourism and Travel Council’s data, and conducted several multiple regression analyses. The results have revealed that especially private investments in the Balkan countries have a strong impact on tourism performance. Additionally, we have found that leisure Travel and Tourism (T&T) receipts, as a type of tourism performance, has potential to contribute to both direct and total contribution to gross domestic product in the Balkan countries. We suggest that governments should allocate sufficient funds to design and promote this core product in the tourism industry. This includes expenditures for environmental sustainability, safety and security, health and hygiene, air and ground transport infrastructure, tourism infrastructure, and information and communication technology infrastructure. In order to raise the gross domestic product, countries should arrange the necessary policy rules and regulations to create an attractive travel and tourism environment, and increase tourism receipts. Key Words: Balkan countries, tourism performance, Gross Domestic Product, public and private investments

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Introduction As developing countries, states in the Balkan region are in the transition stage towards a market driven economy, which requires self-sustained economic and social growth. Those countries have to resolve issues that stem from ethnic, economic, and social problems (Liargovas and Chionis, 2002), and face certain economic problems, such as unemployment, high inflation, currency flows, and the lack of foreign direct investments. In order to resolve economic growth problems, Balkan countries “have seen the tourism industry as a chance of gaining economic profit, and thus become a rival industry to agriculture” (Ardahaey, 2011: 208). Related to the increasing importance of the tourism industry for national economies, in this study, we investigate the impact of tourism investments on tourism performance and gross domestic product (GDP) in Balkan countries. In the following sections, the theoretical framework, methodology, findings, and conclusions of the study will be presented.

Literature Review In today’s competitive and unpredictable business world, the tourism industry is seen as one of the fast growing sectors when compared to others. The industry has been considered to have a direct impact on the economic development of countries (Arasl and Baradarani, 2014: 1416; Thrane, 2008: 522). Evaluating this from a macroeconomic point of view, the tourism industry will help countries to earn receipts, which will, eventually, contribute to local, national, and international economic growth by creating competition among them (Song, et al, 2012: 1664). Therefore, positive changes in tourism demand will help policymakers in the developing economies, because the successful implementation of tourism policies has the potential to create growth and development. In addition to this benefit, economists postulate that the successful implementation of tourism policies will create higher economic growth by creating new business areas and opportunities (Akkemik, 2012: 791). In a similar vein, statistics have displayed that the tourism industry has created 262 million jobs, which composed 8.7% of the total world employment in 2012. In this sense, tourism and travel (T&T) has become one of the most significant job-generating industries in the world economy. According to statistical figures, the T&T industry reached a total contribution of 9.3% of the global GDP, 5% of global investments, and 5% of global exports during the same year. In addition to these figures, the T&T industry has a significant impact on other industries by creating

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indirect benefits and increasing economic development through commercial opportunities, foreign investments, and public-private infrastructural investments (Jucan and Jucan, 2013: 83). In this study, private investments and public investments will be termed as capital investments and government individual investments respectively. The first concept, capital investment, means all the private entrepreneurial spending, which is made by all sectors included directly in the T&T industry. Expenditures made in this category include expenses for hotels, restaurants, entertainment facilities, souvenir shops, tourism vehicles for passenger transportation, etc. According to The World Travel & Tourism Council (WTTC), capital investment for T&T is expected to be 764,7 billion USD in the world in 2012 and it is anticipated to grow by 4.2% in 2013 (WTTC, 2013). In addition to capital investments, investments for tourism infrastructure will reduce risk for private sector entrepreneurs. Governments regard tourism investments as necessary in order to improve regional economy and to attract more tourists (Rosentraub and Joo, 2009: 764). Holzner’s (2011) study anticipated that economies having high tourism revenue in GDP will have faster economic growth than economies with lower tourism revenue in GDP. Also, it is indicated in this chapter that if tourism revenue is higher in GDP, consequently, a certain economy will have a higher level of investment. Other positive consequences include better levels of employment opportunities, new infrastructure investments, ascending tax revenues and inpayments (Tang and Abosedra, 2014: 2). Regarding literature, there are a number of papers that have studied the impact of the tourism industry on economic growth (Tang and Abosedra, 2014; Narayan, Sharma and Bannigidadmath, 2013; Akkemik, 2012; Holzner, 2011; Lee and Chang, 2008; Chou, 2013). Chou’s (2013: 226) study indicated that the relationship between tourism spending and economic growth is within the politicians’ field of interest as part of tourism policies. In this chapter, it is examined whether domestic tourism spending enhances economic growth or not. A main finding of this study is that there is a causal relationship between tourism spending and economic growth in Bulgaria, Romania and Slovenia. Similar findings are postulated in Arasl and Baradarani’s (2014) study which states that an increased number of tourists will create tourism related benefits, such as growth in economic and social development, and infrastructure investments. The contribution of the travel and tourism industry to GDP can be classified into three groups: indirect, induced, and direct contributions.

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277

Indirect contribution to GDP reflects investment spending, several alternative tourism activities and the domestic purchases of goods and services. Conversely, induced contribution is the spending of employees who are employed in the T&T industry. The direct contribution of T&T to GDP is the total T&T expenditures that are made by residents and nonresidents for business and leisure activities. Also, it includes government individual spending for recreational holiday spending, such as museums, national and cultural parks (WTTC, 2013). According to The World Travel & Tourism Council, the total contribution of Travel and Tourism to GDP was 6,630 billion USD and 9.3% of total GDP in 2012. This ratio is expected to rise to 3.2% in 2013. The direct contribution of Travel and Tourism to GDP was 2,056 billion USD and 2.9 % of total GDP in 2012. This ratio is expected to rise till 3.1% in 2013. Research Question 1: Does an increase in public and private investments in the tourism industry cause a better tourism performance in the Balkan countries? Research Question 2: Does an increase in tourism performance in the Balkan countries have a positive impact on direct and total contribution to GDP? Research Model: The Relationships among Tourism Investment, Tourism Performance, and Contribution to GDP

Methodology In this study, we investigate the relationship between investments in the tourism industry, and tourism performance and its contribution to GDP in the Balkan countries. More specifically, we would like to unravel, first, the impact of the independent variables, which are, “government individual T&T spending” and “capital investment”, on the dependent

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variables, which are “tourist arrivals” and “tourism receipts”. We also used two other dependent variables, which are “leisure T&T receipts” and “business T&T receipts” as types of tourism receipts. Additionally, we used the aforementioned dependent variables as independent variables and investigated their impact on Balkan countries’ T&T direct contribution to GDP and T&T total contribution to GDP. In order to investigate the relationship between those variables and to test the model, we have used the WTTC’s economic data for the years 1999 to 2011 for the Balkan countries. In this study, the Balkan countries under investigation are: Albania, Bosnia and Herzegovina (BH), Bulgaria, Croatia, Greece, Macedonia (FYROM), Montenegro, Romania, Serbia, Slovenia, and Turkey. In order to test the model, we used multiple regression analysis and the results are presented in the tables below.

Findings Table 14-1 displays the results for the first regression analysis results for T&T investment in terms of government and public capital investments, and international tourist arrivals. The regression model obtained is significant at the 95% significance level and explains 88% of variance in dependent variable (F=1010.231; p= 0.000; R2= 0.88). Table 14-1: Regression analysis results for T&T investments and international tourist arrivals Beta

Significance of t

1445.937

0.000

0.938

0.000

0.044

0.254

R

F

Significance of F

0.88

1010.231

0.000

Independent Variables Constant Capital Investment Government Individual T&T spending 2

*Dependent variable: Tourist Arrivals

As it can be observed in Table 14-1, two independent variables, capital investment and government individual T&T spending, statistically have significant impact on international tourist arrivals, as the dependent variable. The scores imply that the most significant variable to influence tourist arrivals is capital investment, which accounts for an 88% variance in dependent variable (Beta= 0.938; p= 0.000). The other independent

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279

variable, government individual T&T spending, has not been statistically found to have a significant influence on tourist arrivals in the Balkan countries (Beta= 0.044; p= 0.254). It can be inferred from Table 14-2 that T&T investments, in both the public and private sectors, have a statistically significant impact on tourism receipts (F= 506.831; p= 0.000; R2= 0.89). Capital investment as an independent variable explains 89% of the variance in dependent variable (Beta=1.011; p= 0.000). The second independent variable, government individual T&T spending, explains a very small amount of variance in the dependent variable (0.008%), which can be omitted in explanation of the model (Beta= -0.117; p= 0.003). Thus, we can conclude that capital investment can be counted as the major influence on tourism performance in the Balkan countries. Table 14-2: Regression analysis results for T&T investments and tourism receipts Beta

Significance of t

1251.920

0.000

1.011

0.000

-0.117

0.003

R

F

Significance of F

0.89

506.831

0.000

Independent Variables Constant Capital Investment Government Individual T&T spending 2

*Dependent variable: Tourism Receipts

The third regression analysis results have been portrayed in Table 14-3. The results imply that tourism performance, in terms of leisure T&T receipts, has been influenced by capital investment and government spending (F= 816.674; p= 0.000; R2= 0.92). Capital investments explain 92% of variance in the dependent variable (Beta= 1.005; p= 0.000) and government spending has a minor contribution to the model (Beta= -0.72; p= 0.022) and is omitted.

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Table 14-3: Regression analysis results for T&T investments and leisure T&T receipts Beta

Significance of t

825.994

0.012

Capital Investment

1.005

0.000

Government Individual T&T spending

-0.072

0.022

R2

F

Significance of F

0.92

816.674

0.000

Independent Variables Constant

*Dependent variable: Leisure T&T receipts

Regression analysis results in Table 14-4 show that business T&T receipts have been impacted by capital investments (Beta= 0.874; p= 0.000) in the Balkan countries, and the model is significant at the 95% significance level (F= 457.044; p= 0.000; R2= 0.77). Table 14-4: Regression analysis results for T&T investments and business T&T receipts Beta

Significance of t

212.191

0.022

Capital Investment

0.874

0.000

Government Individual T&T spending

-0.054

0.312

R2

F

Significance of F

0.77

457.044

0.000

Independent Variables Constant

*Dependent variable: Business T&T receipts

We analysed the impact of tourism performance on T&T direct contribution to GDP and results are presented in Table 14-5. It can be observed from the Table that leisure T&T receipts are the most influential variable (Beta= 0.956; p= 0.000), followed by business (Beta= 0.162; p= 0.000) and tourism receipts (Beta= -0.107; p= 0.000) variables.

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Table 14-5: Regression analysis results for tourism performance and T&T direct contribution to Gross Domestic Product Beta

Significance of t

-283.042

0.000

Leisure T&T receipts

0.956

0.000

Business T&T receipts

0.162

0.000

Tourism receipts

-0.107

0.000

R

F

Significance of F

0.99

24308.825

0.000

Independent Variables Constant

2

*Dependent variable: T&T direct contribution to GDP

In Table 14-6, the impact of tourism performance on T&T total contribution to GDP is shown. Results indicate that the dependent variable, T&T total contribution to GDP, is influenced by leisure T&T receipts (Beta= 0.967; p= 0.000), business T&T receipts (Beta= 0.141; p= 0.000), and tourism receipts (Beta= -0.100; p= 0.000) variables. Table 14-6: Regression analysis results for tourism performance and T&T total contribution to Gross Domestic Product Beta

Significance of t

-126.412

0.409

Leisure T&T receipts

0.967

0.000

Business T&T receipts Tourism receipts

0.141

0.000

-0.100

0.004

R2

F

Significance of F

0.99

7836.686

0.000

Independent Variables Constant

*Dependent variable: T&T total contribution to GDP

Average capital and government investments (1999 to 2011) for the Balkan countries can be observed in Table 14-7. It can be deducted from the Table that the level of capital investments is much higher than government investments during the same period of time. A comparison of the two types of investments would lead us to the contention that the level

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of government spending in the T&T sector is relatively small as compared to capital investments made by the private sector. This can be the reason for why the government investments variable is not an influential variable when explaining the variance in tourism performance, when the regression model is run (see Table 14-3 and Table 14-4). Table 14-7: Average capital and government investments (Millions USD) Country

Capital Investment

Government Individual T&T spending

Albania

159.46

3.84

Bosnia & Herzegovina

109.92

3.07

Bulgaria

647.69

20.76

Croatia

1.161.53

113.84

Greece

6.580.76

38.46

Macedonia

31.53

0

Montenegro

132.38

0

2.022.15

51.61

Serbia

119.38

4.61

Slovenia

510.53

36.15

8.426.76

40.00

Romania

Turkey

Conclusion Our findings have revealed the fact that tourism performance has mostly been influenced by private investments in the Balkan countries. More specifically, the level of tourist arrivals, tourism receipts, leisure T&T receipts and business T&T receipts have been influenced by private investments. This result seems logical because it is expected that investments made for hotels, restaurants, souvenir shops, entertainment facilities, convention centers, golf courses etc. will increase the level of direct tourism demand. The reason why government investments was not a significant variable in regression analyses would be that government spending in the Balkan countries is a relatively small amount when

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283

compared with capital investments (private investments). Furthermore, the amount of government spending is quite limited and far from influencing the tourism demand in those countries. Another explanation to this issue would be the contention that government investments by nature are infrastructure investments and do not have a direct impact on customer preferences. In light of the above discussions, we can recommend that governments and local authorities in the Balkan countries first have a better systematic plan to solve issues stemming from the lack of public expenditures, which could not be found to influence tourism performance. In this sense, governments of these countries should develop tourism plans by getting the support of all stakeholders such as, local authorities, non-governmental organisations, and firms for accommodation, travel, and supporting industries. In order to design and promote the core product in the tourism industry, governments especially should allocate a significant amount of budget funding. This budgeting should cover expenditures for environmental sustainability, safety and security, health and hygiene, air and ground transport infrastructure, tourism infrastructure, and information and communication technology infrastructure. In addition to these expenditures, governments should also develop human, cultural, and natural resources by investing into tourism education, protected areas, and World heritage cultural sites. Our second major finding is that tourism performance, in terms of tourism receipts, has a direct impact on economic performance of the Balkan countries. Leisure T&T receipts were found to have a statistically significant impact on the T&T direct and total contributions to GDP. The impact of leisure T&T receipts would be explained by its amount, which is much higher in comparison with business receipts. Another explanation for this would be that receipts from leisure activities are more diverse and take more time. Concerning the strong relationship between receipts from leisure activities and the country’s economic performance, in the form of GDP, governments should arrange the necessary policy rules and regulations, such as foreign ownership, property rights, cost to start a business, visa requirements etc.

References Akkemik, K. A. (2012). Assessing the Importance of International Tourism for the Turkish Economy: A Social Accounting Matrix Analysis. Tourism Management, 33, 790-801.

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Araslı, H., & Baradarani, S. (2014). European Tourist Perspective on Destination Satisfaction in Jordan’s Industries. Procedia-Social and Behavioral Sciences, 109, 1416-1425. Ardahaey, F. T. (2011). Economic Impacts of Tourism Industry. International Journal of Business and Management, 6(8), 206-215. Chou, M. C. (2013). Does Tourism Development Promote Economic Growth in Transition Countries? A Panel Data Analysis. Economic Modelling, 33, 226-232. Holzner, M. (2011). Tourism and Economic Development: The Beach Disease? Tourism Management, 32, 922-933. Jucan, C. N. & Jucan, M. S. (2013). Travel and Tourism as a Driver of Economic Recovery. Procedia Economics and Finance, 6, 81-88. Lee, C.-C., & Chang, C.-P. (2008). Tourism Development and Economic Growth: A Closer Look at Panels”. Tourism Management, 29, 180-192. Liargovas, P. & Chionis, D. (2002). Barriers to the Transition of Enterprises from Central Plan to Market Economy: The Balkan Case. Journal of Sothern Europe and Balkans, 4(2), 191-206. Narayan, P. K., Sharma, S. S., & Bannigidadmath, D. (2013). Does Tourism Predict Macroeconomic Performance in Pacific Island Countries? Economic Modelling, 33, 780-786. Rosentraub, M. S., & Joo, M. (2009). Tourism and Economic Development: Which Investment Produce Gains for Regions? Tourism Management, 30, 759-770. Song, H., Dwyer, L., Zheng, C., & Gang L. (2012). Tourism Economics Research: A Review and Assessment. Annals of Tourism Research, 39(3), 1653-1682. Tang, C. F., & Abosedra, S. (2014). The Impact of Tourism, Energy Consumption and Political Instability on Economic Growth in MENA Countries. Energy Policy, 68, 458-464. Thrane, C. (2008). Earnings Differentiation in the Tourism Industry: Gender, Human Capital and Socio-Demographic Effects. Tourism Management, 29, 514-524. World Travel & Tourism Council. (2013), Travel and Tourism Economic Impact 2013 World. Retreived from http://www.wttc.org/site_media/uploads/downloads/world2013_1.pdf

CHAPTER FIFTEEN TURKEY’S TOURISM EXPERIENCE: IMPLICATIONS FOR BOSNIA AND HERZEGOVINA TEOMAN DUMAN Abstract: The purpose of this review is to analyse Turkey’s tourism experience and identify implications for future tourism planning in Bosnia and Herzegovina. To achieve this purpose, the significant developments in Turkish tourism in the past 100 years were identified in a framework and cross-analysed with the needs of Bosnia and Herzegovina’s tourism industry. The review results suggest that Turkey’s experiences with tourism regulation (incentive) systems and marketing efforts can have significant implications for tourism planning in Bosnia and Herzegovina. Key Words: Tourism, Bosnia and Herzegovina, Turkey

Introduction According to the World Tourism Organisation, global tourist arrivals approached the one billion thresholds, and all countries trying to get their share of that wealth (UNWTO, 2014). The tourism industry has always been seen as a generator for economic development. With its effects on production, exports and employment, the industry provides immediate solutions to many economic and social problems. The tourism industry is especially important for countries like Bosnia and Herzegovina (BH), where the economy is in transition and economic development is slow. In underdeveloped and developing countries, many examples can be found in which the tourism industry acts as an economic generator. In Turkey, for example, tourism was seen as a solution to immediate economic and social problems. Turkey’s tourism industry has contributed about 5% of the country’s total GDP, creating around 800,000 jobs in the past decade (T.C.

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Kültür and Turizm Bakanl÷, 2011). As the share of tourism in world economies increases, tourism will remain a priority industry for countries like Turkey and BH. This chapter is prepared to initiate discussion on a cross-country analysis of the tourism industries in BH and Turkey. As globalisation turns the world into a single market and a single destination, countries are looking for ways to combine and benefit from each other’s experiences. Tourism, in this regard, is a sector where joint work is much needed. In this chapter, the significant developments in Turkish tourism over the last 100 years were identified in a framework and cross-analysed with the needs of Bosnia and Herzegovina’s tourism industry. An analysis of the strong and weak points in each country’s tourism development will open up new channels for research. In the following sections, an analysis of tourism development in Turkey and in BH will be provided.

An Evaluation of Turkey’s Tourism Experience During the past decade, Turkey has enjoyed being among the top ten tourist destinations in terms of visitor numbers. Table 15-1 presents the top ten destinations in the world based on tourist numbers and earnings. As seen in the Table, Turkey attracts around 35 million tourists every year. The nation’s total earnings from tourism in 2013 were 27.9 billion USD according to the United Nations World Tourism Organisation (UNWTO, 2015). Turkey’s experience with tourism has been a positive one due to its gradual development during the last 50 years. Table 15-2 presents summary statistics on the number of tourists, tourism earnings, spending per tourist, employment numbers, number of hotels and number of beds in that 50-year period. To get a deeper understanding of the increase in the numbers in this Table, phases of tourism development in the country were identified and presented in Table 15-3. As shown at top of the Table, four main phases of development are identified, and these phases indicate a roadmap for greater capacity of entrepreneurship in Turkish tourism. These phases are policy, infrastructure/superstructure development, management and marketing. These four phases were further broken down into 6 stages that identify key turning points for Turkish tourism from the last 100 years of Turkey’s history. These stages were identified based on major events and policies that dominated the identified time period. These stages are awareness and initial policy development, institutionalization, second policy and infrastructure development, competition and third policy development/globalisation. In the following sections, further explanations will be given for each stage.

Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina 287

Table 15-1: Top ten destinations in the world (2013) Rank

Country

Number of Tourists (million)

Country

Tourism Earnings (Billion $)

1.

France

83.0

US

2.

US

66.7

Spain

60.4

3.

Spain

60.7

France

56.1

4.

China

55.7

China

51.7

5.

Italy

47.7

Macao (China)

51.6

6.

Turkey

37.8

Italy

43.9

7.

Germany

31.5

Thailand

42.1

8.

UK

31.2

Germany

41.2

9.

Russian Federation

28.4

UK

40.6

10.

Thailand

26.5

Hong Kong (China)

38.9

139.6

Source: United Nations World Tourism Organisation (UNWTO, 2014)

1,300,000

5,400,000

10,400,000

28,510,000

31,320,000

31,340,000

33,820,000

35,850,000

1980

1990

2000

2010

2011

2012

2013

2014

27,778,000,000

25,322,000,000

22,410,000,000

22,220,000,000

19,110,000,000

7,600,000,000

2,700,000,000

326,000,000

52,000,000

Tourism Earnings ($)

775

749

715

709

670

730

621

254

71

Tourism Spending Per Tourist ($)

890,000

838,000

715,000

645,000

477,000

543,000

294,000

-

-

-

2982

2870

2783

2650

1820

1260

292

292

Number of Hotels

-

749,000

706,000

668,000

630,000

325,000

173,000

28,000

25,000

Number of Beds

Sources: Akin, Simsek, and Akin, (2012); Coban and Ozcan, (2013); Gulbahar (2009); Turkish Association of Travel Agencies (2015; April 28); Turkish Statistical Institute (2015; April 28); Turkish Ministry of Culture and Tourism, 2015; April 28); T.C. Kültür ve Turizm Bakanl÷ (2011); Yldz (2011); Turofed (2010); TURSAB (2014; January 21)

724,000

Number of Tourists

1970

Year

Employment

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Table 15-2: Summary statistics for Turkish tourism

288

Infra/super-structure Management

2. Extension of tourism incentives for golf, winter, mountain, thermal, y

2. Environmental Protection Act (1983)

2. Transfer of responsibility of regional tourism planning to the Tourism Ministry (1970)

2. Establishment of Press, Publication and Tourism General Directory (1949)

3.Tourism Incentives Acts (1950, 1953)

1. Increase in the number of tourism establishments

1. Tourism Incentive Act (1982)

1. Establishment of Tourism and Promotion Ministry (1963)

1. Establishment of Office of Tourism within Ministry of Economy (1934)

Major indicators

1985 - 1995

1980 - 1990

1960 - 1980

3. Establishment of Association of Travel Agencies (TURSAB) (1972) 4. Privatisation of tourism facilities (1987)

3. Identification of tourism zones, areas, and centers for incentives

3. Restoration of historical and cultural assets

Žlacht, and entertainment tourism in the 6th Development Plan (1990)

Superstructure Development- Service Emphasis (Education)

Stage 4

1923 - 1960

Second Policy Development – Infrastructure Development

Stage 3

Years initiated

Stage 2

Awareness and Initial Policy Development

Stage

Institutionalization

Stage 1

Stage #

Roadmap for greater capacity of entrepreneurship in Turkish tourism

Policy

Table 15-3: Stages of tourism development in Turkey

2. Reorganisation of tourism governing bodies

2. Product differentiation

4. Certification of tourism facilities and focus on service quality (regulation on service quality standards—blue flag, green and

7. Bids for Olympics and Expo

6. New tourism incentives under KOSGEB

5. New tourism regions, corridors, cities

4. Branding

3. Focus on education

1. Turkish Tourism Strategy 2023 (2007) 1. Product development

3. All-inclusive vacation sales

2005 - Current

Third Policy Development - Globalisation

Stage 6

Marketing

1995 - 2005

Competition

Stage 5

Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina 289

4. Establishment of Tourism Bank (TURBAN) to finance tourism development activities (1954)

4. Establishment of State Planning Organisation (DPT) (1960) 4. Increase in the number of tourism education facilities

Chapter Fifteen white stars) 8. Countrywide service infrastructure (165 hotel chains in Turkey; 53 airports all over the Country)

Sources: Investment Support and Promotion Agency of Turkey (2013, December); Karan (1994); T.C. Kültür ve Turizm Bakanl÷ (2007); T.C. Kültür ve Turizm Bakanl÷ (2007a); T.C. Kültür ve Turizm Bakanl÷ (2007b); T.C. Kültür ve Turizm Bakanl÷ Yatrm ve øúletmeler Genel Müdürlü÷ü (2012, July); Tezcan, Karadeniz, Kandr, and Önal, 2008); Toker (2007); TURSAB (2014; January 21); Soyak, (2013); Vakiflar Genel Müdürlü÷ü (2014); Var (2014)

290

Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina 291

Stage 1: Awareness and Initial Policy Development The period from the establishment of the new Turkish Republic on 29 October, 1923, to the famous military coup of 1960 can be considered as a period of awareness and initial policy development. This period is remembered for its heavy government inducement in different sectors, as the government was actively involved in business activities. Turkish tourism capacity was low in this period, with 258 accommodation facilities and 15,685 beds available in 1961. That same year, 129,000 tourists visited Turkey, spending 7.5 million USD. During this period, the initial establishments of tourism offices and directorates were completed. Major incentives for the tourism industry were also started with tourism incentive acts in 1950 and 1953, with incentives supported by tourism credits given by the famous public tourism bank, TURBAN (Turizmhaberleri, 2013). TURBAN engaged in many different activities to initiate examples of entrepreneurship for Turkish investors, including a travel agency, seaside resorts, touristic restaurants, a tourism education facility with a practice hotel and restaurant, hotels, motels, winter resorts and marinas (Karan, 1994). TURBAN funded 22 tourism businesses, offering a total capacity of 7,024 beds. Additionally, TURBAN initiated holiday credits for domestic vacationers in Turkey. Even though TURBAN facilities were operated professionally for many years, in time they experienced heavy losses, putting a burden on the public budget. These facilities were privatized like many other government-owned facilities in 1987 (Ozellestirme Idaresi Baskanligi, 2014; Karan, 1994).

Stage 2: Institutionalization The second period in Turkish tourism can be considered as an institutionalization period. The Tourism and Promotion Ministry was established in 1963, which meant that tourism planning and development would be highly centralized. In 1970, the responsibility of regional tourism planning was given to this Ministry. Today, the Ministry of Culture and Tourism has a nationwide organisation that controls all tourism development activities in the country through city directorship offices. In all 81 cities, the ministry has well-structured, centrally-governed directorship offices. Another important development in this period was the establishment of TURSAB, the Association of Travel Agencies (TURSAB, 2014; January 21). From that time on, TURSAB has been operating as an umbrella organisation, and all travel agencies have to register and work according to TURSAB’s regulations. TURSAB

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represents more than 6,000 travel agencies in Turkey. The establishment of the State Planning Organisation in 1960 was also part of the institutionalization of tourism planning activities because major tourism plans were identified by this organisation in its 5-year development plans, as approved by the central government (Gulbahar, 2009; Soyak, 2013; Var, 2014).

Stage 3: Second Policy Development – Infrastructure Development This is an important period in Turkish tourism history due to the famous acts that influenced the development of tourism activities in Turkey. These acts include the Tourism Incentive Act (1982), the Environmental Protection Act and the National Parks Act (1983; Toker, 2007). All major regulations that influenced later years’ tourism developments were initiated in this period (Var, 2014). Tourism zones, areas and centers for incentives were identified in this period. The famous Tourism Incentive Act of 1982 gave investors a chance to benefit from free land on a 49-year lease, credit of up to 60 percent through the Tourism Bank, and long-term, low-interest-rate credit through the Tourism Encouragement Fund. Investors set up and operated casinos, received permission to serve alcoholic beverages, benefited from special utility rates for hotels, and were encouraged to employ people of foreign nationalities in the tourism sector. These initiatives started large-scale development activities in Turkey’s coastal areas. Overall, by 1990, the number of tourism establishments rose to 1,260, with a 170,000bed capacity (Table 15-1). Despite the slow pace of change, the government privatized public tourism facilities during this and later periods.

Stage 4: Superstructure Development- Service Emphasis (Education) Parallel with infrastructure development in the 1980s, superstructure development and service emphasis accelerated. Modern tourism facilities with improving service standards were increasing in this period, which later attracted attention from all major demand-generating countries. The number of tourism establishments surpassed 1,800, and the total number of annual visitors approached 10 million during this period. This period is also known for the new awareness of a more comprehensive tourism

Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina 293

product development. The government extended tourism incentives through the 6th Development Plan in 1990 for different tourism types including golf, winter, mountain, thermal, yacht, culture, and entertainment tourism. A noteworthy superstructure development has been the work of the Directorate General of Foundations. This directorate has done considerable inventory work on historical and cultural assets in Turkey, followed by the restoration of all major assets to be utilised in the tourism industry. In the last 15 years, this directorship has restored 3,400 assets, and rented out or opened many of them for use in the tourism industry (Vakiflar Genel Müdürlü÷ü, 2014). Cultural and historical tourism has grown quickly as a result of this directorship’s recent work. As the number of establishments grew, especially in coastal areas, the need for qualified service personnel grew accordingly. In this period, the government placed a heavy emphasis on tourism education and increased the number of tourism education facilities, including short courses, high schools, two-year professional colleges and four-year university programs. During this period, the overall estimate of the number of schools giving tourism education quadrupled (from 50 to 200). In time, the variety of the tourism programs in short courses, high schools and universities increased to meet the increasing demand from tourism establishments. Today, in universities alone, there are 732 tourism-related programs, educating 38,300 students all over the country.

Stage 5: Competition This period is remembered for the heavy competition from neighbouring countries’ Mediterranean destinations. Turkey had by this point become a mass tourism destination, attracting tourists from major demandgenerating countries in Europe. In this regard, it was becoming an important competitive force in the market of other destinations in the Mediterranean region. Turkey’s annual tourist numbers were approaching the 20 million thresholds, and with all the investments, patience was not shown for the new facilities’ excess capacity. At this point, at the central government level, certification efforts made gains to create standards for the Turkish tourism product. Meanwhile, at the sector level, marketing efforts gained speed by standardizing the product through all-inclusive vacations. In 2005, the Ministry of Culture and Tourism issued a regulation on quality standards, establishing minimum standards in order to improve quality in tourism establishments.

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Table 15-4 Content of all-inclusive vacations Types of All-inclusive Vacations

Ultra/High Class

Types of Services Included in the Package Accommodation Maximum Imperial Classic Three meals a day Snacks during the day Unlimited domestic, cold/hot, alcoholic/nonalcoholic drinks Unlimited imported food and beverage Entertainment activities Limited use of sport facilities Children’s clubs Frozen foods Unlimited imported cold/hot, alcoholic/nonalcoholic drinks Open buffet and ala carte restaurant service Unlimited use of land and sea sport facilities Theme restaurant service Unlimited sea sport facilities Sauna, Turkish hammam, aerobic services Free minibar services Use of sea motorsport facilities Daycare service Laundry service Telephone and fax services from rooms Internet services Special health service packages

Source: Menekúe (2005)

Most seaside resorts and hotels presented their products in vacation packages that combined all aspects of the vacation in a single price, which travel agencies and tourists found to be very attractive. All-inclusive vacations came in different formats, such as classic, maximum, imperial and ultra-high, as based on the extent to which the single price covered the

Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina 295

vacation’s amenities, including travel, food and beverage, excursions and entertainment (Duman and Kozak, 2010). Types and content of allinclusive vacations are presented in Table 15-4 (Menekse, 2005). Following the marketing efforts for all-inclusive vacations, a great majority of holiday packages sold came from this type of product. One reason hotel establishments were successful in applying the all-inclusive concept was the reasonable food and beverage prices in the Antalya region, as this region is Turkey’s fresh food source. The all-inclusive concept also received a lot of criticism because it reduced prices and profitability levels. However, this concept was also praised for promoting the country and increasing employment (Turofed, 2010). Turkey’s tourism development efforts bore fruit, and it became the 19th most popular destination in the world in 1997. Turkey became known in most world markets by the turn of the new millennium. Following the year 2000, tourist numbers increased at such a fast pace that by 2005, the nation was attracting over 20 million tourists annually, making it one of the top ten destinations in the world. Increasing tourist numbers encouraged public policy makers and sector representatives to focus more on product development and differentiation efforts. Product development was partly achieved by enriching the content of the holiday product. As part of product development, the tourism experience in the holiday package was upgraded by including separate entertainment activities in the package. Holidays were made to be less complicated and more enjoyable for different types of tourists, especially for families. Different resources in the regions, such as caves, mountains, and deltas were used to enrich the tourism experience, which contributed to product development. In the same period, the ministry placed heavy emphasis on product differentiation efforts. The Ministry categorized tourism by types: sunsand-sea, historical (faith-based, religious), environmental (ecological, adventure, hunting, winter), cultural (ethnic, heritage-based), thermal (wellness, spa) and urban (business, cultural, sports, educational). With these product differentiation efforts, the Ministry aimed to provide different types of tourism products to different target groups by extending tourism demand to different regions of the country and to different seasons of the year. This strategy helped in reaching different demographic and geographical tourism markets.

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Stage 6: Third Policy Development – Globalisation As the country gained the capacity to host over 30 million tourists, the ministry made a new effort to devise a long-term plan for Turkish tourism in this period (2007). Called “the Turkish Tourism Strategy 2023”, it identified new governing bodies for the structure of tourism leadership. The strategy also introduced new goals for regional tourism development, education and branding. To spread tourism to all the country’s regions, new tourism regions, corridors and cities were identified. All the regions of Turkey can be reached from the country’s 53 airports, and major hotel chains can be found in all parts of the country, with165 hotel chains operating in Turkey today (Investment Support and Promotion Agency of Turkey, 2013, December). Currently, the Ministry is trying to implement the activities established in the strategy. It is known that Turkey is still a mass tourism destination and that 25% of all hotels and half the bed capacities are in Antalya. The other cities with large bed capacities are Mu÷la (90,000), Istanbul (73,000) and øzmir (29,000). To achieve the branded tourism cities’ goals, the government entered bids for the Olympics and Expo 2015. Despite being unsuccessful in these bids, the government has plans to invest heavily in certain cities to make them world-renowned destinations. To encourage tourism development in different regions, tourism incentives given by the Small and Medium Enterprises Development Organisation (KOSGEB) were extended to tourism enterprises (T.C. Kültür ve Turizm Bakanl÷ Yatrm ve øúletmeler Genel Müdürlü÷ü; 2012, July). Sources of incentives available to tourism investors include the following (Investment Support and Promotion Agency of Turkey, 2013; Tezcan, Karadeniz, Kandr, and Önal, 2008): 1. Investment support provided by KOSGEB 2. Investments made under the decree of the Council of Ministers 3. Incentives made under Law no. 2634, regulating the incentives for the tourism sector 4. Exempted items listed under Law no. 1319, regulating some tax exemptions 5. Loans provided by EXIM Bank 6. Incentives for foreign direct investments Types of incentives and support for tourism investors in Turkey include the following (Investment Support and Promotion Agency of Turkey, 2013):

Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina 297

Tourism loans: The Tourism Bank, Inc., of the Republic of Turkey can allocate loans originating from foreign funds to tourism investments. Allocation of public land to investors: Investors can rent public land for up to 49 years, depending upon the investment type, facility capacity and location characteristics. Employment of foreign personnel and artists: Establishments that have a tourism certificate can employ foreign staff, up to 10% of the total number of employees, if approved by the Ministry of Labour and Social Security. This ratio can be increased with the approval of the Ministry. Foreign employees are able to start work not more than 3 months prior to the opening of the establishment. Communication facilities: Applications and requests for telephone and telex facilities by certified tourism establishments are regarded as a government priority. Rates of utilities: Certified tourism establishments pay the lowest possible rates for their gas, electricity and water bills. Sale of alcoholic beverages and lotteries: To the extent that the ministry gives permission, certified tourism establishments are exempt from the provisions of article 178 of Public Health Law no. 1593 and of article 61 of the Elementary Training and Education Law no. 222, which are concerned with the sale of, and licenses for alcoholic beverages. Tourism Development Fund: A Tourism Development Fund has been established to support tourism investments for tourism centers in areas of cultural interest, for those that require preservation and those located in developing regions. These loans have a maximum repayment period of 20 years for up to 15% of the total investment cost and can be spent on the development of foreign marketing opportunities. Investments that are made in accommodation and entertainment facilities, restaurants, convention and exhibition centers, golf and yacht facilities and tourism complexes benefit from incentives under the scope of the law for the encouragement of tourism.

An Evaluation of Bosnia and Herzegovina’s Tourism Governance and Potential As a post-war, transitional economy, Bosnia and Herzegovina has been struggling to establish a sound system in every aspect of its governance structure. Its tourism system has also been undergoing serious

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restructuring after the break-up of the former Yugoslavia in 1995. Overall, it is well accepted in the country that tourism is a valuable source for development and that the country should be developed to benefit from it (USAID, 2006). So far, despite not reaching the desired level, tourism development in the country has been stable. The direct contribution of travel and tourism to BH’s economy was around 2% of GDP in the last two years; tourism brought in 533.4 million BAM (a local currency with fixed exchange rate at 1.9558 BAM for one Euro) in 2011 (World Travel and Tourism Council, 2012). In terms of contribution to employment, the sector directly created 1.8% of the jobs in the country (21,000), while the total contribution to employment, including induced employment in other sectors, was 76,500. The number of international visitors to the country was approximately 400,000 in 2012, and these visitors generated around 1 billion BAM in visitor exports (Agency for Statistics of Bosnia and Herzegovina, December 17, 2012; USAID, 2011). If day trippers, diaspora and religious visitors are counted, then the number of visitors will more than triple the official numbers. There has been a steady increase in international tourist numbers over the last five years, from 150,000 to the current figure; most tourists come from Croatia, Serbia, Slovenia, Italy, Turkey, Poland, Germany and Austria (Nurkovic, 2009). The increase in tourist numbers in the Republic of Srpska (RS) is slower than in the Federation (USAID, 2011). Overall occupancy in the country is low (25%), with occupancy in the RS being higher (43%) than that in the Federation (18%). The main areas of tourism in BH are nature and culture tourism (USAID, 2006). In terms of nature tourism, winter, thermal, hunting and natural sports tourism are the strongest areas (Foreign Investment Promotion Agency, 2013). A number of winter sport centers are available (Ministry of Trade and Tourism, Republic of Srpska, 2014, January 21). Among these are facilities that were used during the 1984 Olympic Games, Igman, for example, which is known to have the highest-quality air (highest share of ozone) in Europe. BH’s thermal resources are among the top three in the Balkans region, and among the top ten in Europe. The country has a total of around 400 accommodation facilities, with a 25,000 bed capacity. The majority of tourists come from neighbouring countries, other European countries and Turkey. The overall average time spent in the country is 2.5 days, although this number rises to 5 days for stays in spa facilities. An analysis of the country’s tourism potential and statistical figures shows that the tourism industry promises a bright future for the country’s economy and political stabilization. It is a well-known fact that

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the tourism industry can bring peace, understanding, economic prosperity, employment and overall development to a country, all of which in fact are needed in BH in the near future.

Turkey’s Tourism Experience and Implications for Tourism in Bosnia and Herzegovina A summary of comments on BH’s tourism governance and potential is presented in Table 15-5. The comments presented in the Table are collected through a literature review of previous studies and reports on the subject (please see the note below the Table for the references used for collection). The comments in the Table will be summarized under four headings, namely policy, infrastructure/superstructure, management and marketing; a discussion of Turkey’s experience on the subjects will be provided.

Policy In BH, tourism governance is mostly decentralized. At the federal level, four cantons (Posavski, Sarajevo, Tuzla, Hercegovacko-Neretvanski) and the federal government have tourism ministries. In the Republic of Srpska, there is a tourism ministry, with tourism governance in this part of the country being centralized. Overall, as research also shows in Table 15.5., tourism governance and planning are very much dispersed. This effects the coordination and planning of tourism activities. The country lacks a national authority that will produce policies for the whole country’s tourism development. Together with political and economic instability, tourism seems to suffer from unhealthy development. The dispersed governance structure also seems to effect cultural heritage protection, privatisation, and visa barriers for tourists, tax policies, business development and entrepreneurship, fair competition and cooperation between sectors, effective incentive systems and regional strengths. Although there may be good examples of all the mentioned issues at the entity level, the lack of a unified structure and policy development in the country seems to make it harder for investors and tourists to grasp the country’s benefits.

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7.

6.

5.

4.

3.

2.

1.

#

Political and economic instability

Lack of central planning due to decentralized nature of governing structure Need for national-level public sector body to coordinate tourism activities and marketing

Potential for spa and health (therapeutic thermal) tourism

Low labour and energy costs as incentives for system development Potential to use improved proximity among former Yugoslavian countries

Need for better tourism organisation

Potential to provide value due to low energy costs

Potential to improve rail transportation system

Need to develop railway from Sarajevo to Mostar for tourism purposes

Potential to provide value due to low labour costs

Proximity to demandgenerating countries in Europe High awareness of the benefits of tourism

High potential for product development and differentiation

Expertise in short cultural and event tours, and winter tour packages

Management

Potential to develop natural parks as tourism centers

Potential for sea-sun-sand tourism in Neum.

High potential for nature tourism (rivers, caves, mountains)

Infrastructure/ Superstructure Potential for organic farming to support tourism industry

High awareness of the benefits of tourism

Master plans are available for major tourism attractions.

Policy

Table 15-5. A summary of BH’s tourism governance and potential

300

Positive image for Eastern markets (i.e. as a European destination)

Potential of Mostar and other cities as tourism destinations

Potential of Sarajevo as a major tourism destination

Potential to utilise mix of cultural assets from Mediterranean, European, Ottoman, Roman and other cultures

Potential to attract neighbouring countries for winter tourism

High potential for winter (ski), spa, religious, culture, easy adventure, mountain, nature/scenic discovery and rural tourism Potential to develop winter tourism products as reasonable alternatives to expensive European counterparts

Marketing

Visa barriers for potential tourists

Poor regulations on tax policy in the tourism sector

11.

12.

16.

15.

14.

13.

Underdeveloped agriculture and food industry Inadequate health and safety infrastructure

Low level of cooperation between private and public sectors

Need for different types of accommodation such as campsites, youth hostels, and rural bed and breakfasts

Unfair competition due to informal economy

Lacking implementation of tax collection, business registration, urban planning, and health and safety laws Incomplete tourism master plan for the country

Reasonable infrastructure and superstructure development in winter tourism areas Insufficient number of hospitality and tourism facilities

Incomplete/insufficient privatisation

10.

Lack of hotels and tourism facilities in attractive tourism locations Lower bed capacity in Republic of Srpska compared to other regions

Need to improve airport facilities

Need for policy development to protect cultural heritage

9.

8.

Inadequate transportation infrastructure to reach inner parts of the country

No national policy for tourism development

Low service quality in tourism facilities – lack of tourism education

Need for tourism associations that will help public bodies to improve tourism services (signage, printed material, etc.) Need for strategy for events/festivals tourism

Weak professional trade associations

Lacking network between tourism information centers

Need for cultural heritage site management

Low overall occupancy rates— need for spreading tourism capacity to different seasons. Travel agencies are mostly small-scale with 4-8 full-time employees Need for better quality health and safety management

301

Negative image of safety created by government reports (e.g. from the U.S. government) Lack of sample world-class tourism products

Weak destination image for European market (e.g., safety, product quality)

Lacking marketing of the 1984 Olympics

Lack of benefiting from religious elements in culture and religious tourism. Need for niche marketing for specific target markets (adventure, culture, religion, rural tourism markets, etc.) Weak branding of tourism attractions

‘Warm welcome’ and hospitality as part of tourism product

Potential to use nearby destinations to create value packages (e.g., Plitvice, Dubrovnik)

Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina

Need to focus on Herzegovina region for its potential to become international tourism destination Need for tourism research for policy development, management and marketing of tourism in the country Land mines and safety problems

Low growth rate in accommodation and foodbeverage sector products

Need for vocational training on specific tourism areas (guide training, adventure sports training, etc.)

Limited number of tourism education facilities—lack of qualified personnel

Lack of inspection of tourism services

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Competition with other European countries

Short length of average stay (2.5 days)

Need for more unique and indigenous products

Sources: Development Bank of Turkey Directorate of Economic and Social Research (2010, January); Foreign Investment Promotion Agency (2013); Investsrpska (2014, January 21); Nurkovic, 2009; Ministry of Trade and Tourism, Republic of Srpska (2011); Ministry of Trade and Tourism, Republic of Srpska (2014, January 21); Nižic, and Drpic, (2013); USAID (2006)

19.

18.

17.

302

Turkey’s Tourism Experience: Implications for Bosnia and Herzegovina 303

In contrast, Turkey has a centralized governance structure. The tourism policy development has been unified for many years. As explained in Table 15-3, starting from 1934, Turkey’s major tourism policies have been identified by governing bodies under the central government. A number of policies and regulations were identified by central authorities and implemented at the country level. Some of these policies and regulations include the establishment of the Tourism Bank, incentive acts, the establishment of TURSAB and regulations in the recent National Tourism Strategy. There are numerous proponents and critics of Turkey’s centralized tourism strategy. For example, proponents have argued that the establishment of the Tourism Bank was correct because this bank initiated all of Turkey’s tourism investments and management models. On the other hand, critics have argued that this was ill-advised because the bank facilities were misused by politicians and bureaucrats. The same arguments can be found regarding many of Turkey’s centralized tourism policies. However, it can be said that Turkey is a good example to analise and determine the potential results of centralized policies on tourism development in countries like BH.

Infrastructure/Superstructure Issues regarding infrastructure and superstructure in BH are related to the consequences of recent conflict in the region. As shown in the review in Table 15-5, the country’s infrastructure and superstructure do not support the necessary levels and quality of tourism service. In all areas, from transportation, to food and beverage, improvements in infrastructure and superstructure are needed to accommodate profitable tourists from different parts of the world. Suggestions to improve facilities in tourist attraction areas, such as national parks, will help, but without the necessary infrastructure, a complete development effort will be hard to realise. A number of investment opportunities are available in the country (Ministry of Trade and Tourism, Republic of Srpska, 2011). Turkey has had quite a positive experience establishing infrastructure and superstructure for a competitive tourism industry. One explanation for Turkey’s success in drastically increasing tourism in the last several decades has to do with its modern facilities, especially on the Mediterranean coasts. Most academics attribute Turkey’s success in infrastructure and superstructure development to well-planned incentive regulations. In particular, the Tourism Incentive Act of 1982 was a major

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motivation for tourism investments. The government’s activities in support of tourism entrepreneurs and infrastructure development have hastened the process, allowing the nation to reach a greater tourism capacity more quickly. Turkey, in this sense, sets a good example for analising how such an improved tourism capacity can be reached in a reasonably short time period.

Management Effective destination management is necessary to develop a competitive destination (Ritchie and Crouch, 2010). The review in Table 15-5 suggests that BH has a lot of potential to be utilised in the management of the tourism sector, but further work is needed to achieve a successful organisation. First of all, a high public awareness exists regarding the benefits of tourism. This awareness can definitely help in unifying and structuring the country’s tourism system. In addition, the review suggests that better organisation of tourism activities is needed to provide complete service to tourists. A combined effort by all entities is needed to support tourism companies and organisations, and provide highquality, safe tourism experiences. In addition, stronger and more active professional trade and tourism organisations are needed to support public tourism work. One expectation from public bodies is to provide better standards and inspections for services. A lack of tourism education facilities seems to be a barrier to developing service standards in the country and for this, a focus on tourism education is needed to increase the number of tourism education facilities. Turkey’s experience with management of the tourism sector is twofold. On the one hand, central government and government-controlled associations like TURSAB, have enacted standards, and local bodies like municipalities have performed inspections of tourism services. The planning and organisation of tourism services in Turkey are actualised by tourism directorates in every city. The central education system in Turkey also places high importance on tourism education, thus providing the qualified workforce that the tourism facilities need. On the other hand, an increasing number of chain hotels and international tour operators have brought significant expertise to the country. Today, 165 hotel chains operate in Turkey, and 732 tourism programs educate young people to provide employment for the industry. Turkey’s experience with tourism management has been a productive one in terms of internationalization and education. However, the country

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has been quite slow in allocating the work to professional tourism organisations or associations. Compared to their counterparts in the USA and Europe, Turkey’s private tourism associations are weaker and more reluctant to take an active role in tourism management. The central government’s role in the management of the industry is still heavy.

Marketing BH has a great potential to develop value tourism products, with its unique qualities like a rich history, a blended culture, past events (such as winter Olympics) and geography. The review (Table 15-5.) suggests that niche tourism products can give BH a unique image that would be easily recognizable in every part of the world. In addition, the country’s proximity to countries like Croatia and Montenegro can be an advantage due to the exchange of information and the chance to develop cooperation in tourism (Nižic, and Drpic, 2013; Ministry of Trade and Tourism, Republic of Srpska, 2014, January 21). BH can provide value (quality travel for reasonable prices) to tourists and serve as a complimentary product for some tour packages in seaside destinations. In this sense, it seems that joint efforts in tourism should produce exemplary tourism products and destinations with strong branding. To direct potential tourists’ attention to the country, branding is needed at every level, from specific products to the country and regional levels. In terms of tourism marketing, Turkey has always enjoyed the benefits of mass tourism. Public and private marketing efforts in the country have been weak, but strong marketing efforts by global tour operators did the necessary marketing work for the country. Starting with a major influx of tourists in the 1990s, marketing was a major issue among tourism professionals. Increasing numbers of tourists forced Turkish entrepreneurs to differentiate their products and give more value to the tourists. As explained previously, all-inclusive tours with rich content increased the value of the tourism product. In addition, the availability of such tourism products encouraged tour operators to sell these products in major demand-generating countries such as Germany. Additionally, government efforts to spread tourism to other parts of the country by using different tourism types helped make the Turkish tourism product marketable. In this sense, Turkey’s efforts in product differentiation are worthy of analysis for potential destinations like BH.

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Conclusion The purpose of this review was to analyse two tourism markets and to identify areas that each can benefit from. Overall, Turkey has extensive experience with tourism planning and marketing. However, Turkey’s experience in planning was very much centralized and controlled by public authorities. On the other hand, Turkey has received much support from strong tour operators, especially those in Europe, for marketing its products. The localization of Turkey’s tourism planning is rather new, and its current strategy of spreading tourism to different parts of Turkey seems to serve as a solid basis for this localization. More active participation of local bodies, such as municipalities, city governments, and trade organisations, will help turn the whole country into an attractive tourism destination. Localization is also necessary to motivate private participation in tourisms efforts through associations, organisations, and clubs. Good examples for Turkey’s tourism investors abound, including examples from the United States (e.g., convention and visitors bureaus). Even though, by nature, Turkey and Bosnia and Herzegovina are different destinations with different attractions, their experiences have much in common. Overall, BH is passing through a transitional period from difficult times to much brighter ones, especially in the area of tourism. Tourist numbers are increasing in the country, but good evaluation and planning are necessary to meet the increasing demand. In this sense, Turkey’s experience with increasing tourist numbers can be beneficial for BH’s authorities. From regulations to management and marketing efforts, Turkey’s experiences can provide insight for future activities in BH.

References Agency for Statistics of Bosnia and Herzegovina (December 17, 2012). Tourism Statistics, First Release, Sarajevo, No 10. Akin, A., Simsek, M. Y., & Akin, A. (2012). The Importance and Place of Tourism in Economy. Journal of Academic Researches and Studies, 4(7), 63-81. Cejvanovic, F., Duric, A., & Vujic, T. (2009). The Competitiveness of Tourism and Rural Tourism Offer in Bosnia and Herzegovina through Application of the Marketing Approach, 113th EAAE Seminar “The Role of Knowledge, Innovation and Human Capital in Multifunctional Agriculture and Territorial Rural Development,” Belgrade, Republic of Serbia.

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Cengiz, Z. (2014, January). Türkiye Turizminin Genel Analizi ve Antalya Odakl Sentezi. Turizm Güncel. Retrieved January 10, 2014 from www.turizmguncel.com/makale/-turkiye-turizminin-genel-analizi-veantalya-odakl-sentezi-m290.html. Coban, O., & Ozcan, C. C. (2013). Türkiye’de Turizm Gelirleri-Ekonomik Büyüme øliúkisi: Nedensellik Analizi (1963-2010). Eskiúehir Osmangazi Üniversitesi øøBF Dergisi, 8(1), 243-261. Development Bank of Turkey Directorate of Economic and Social Research. (2010, January). Bosnia and Herzegovina Sector Reports. Ankara, Turkey. Duman, T. & Kozak, M. (2010). The Turkish Tourism Product: Differentiation and Competitiveness. Anatolia: An International Journal of Tourism and Hospitality Research, 21(1), 89-106 (2010). Foreign Investment Promotion Agency. (2013). Bosnia and Herzegovina Investment Opportunities, Tourism Sector. Sarajevo, Bosnia and Herzegovina. Gulbahar, O. (2009). Emerging of Mass Tourism from 1990’s Until today and Alternative Tendencies in Turkey. Suleyman Demirel Universitesi Iktisadi ve Idari Bilimler Fakultesi Dergisi, 14(1), 151-177. Investsrpska. (2014, January 21). Information regarding Spas in the Republic of Srpska (2012). Retrieved January 21, 2014, from http://www.investsrpska.net/files/Spas_in_the_Republic_of_Srpska.pdf. Investment Support and Promotion Agency of Turkey. (2013, December). Travel and Tourism. Retrieved Jan 21, 2014 from http://www.invest.gov.tr/en-US/infocenter/publications/Documents/ TOURISM-INDUSTRY.pdf Karan, M. B. (1994). Özelleútirme Politikalar ve Turizm Sektöründe Bir Kit: TURBAN A.ù. 3 (49), 239-253. Retrieved from http://dergiler.ankara.edu.tr/dergiler/42/465/5329.pdf. Lawler, B., & Philpot, O. (2010). Central Coast Destination Management Plan for Tourism 2010 to 2013. Earthcheck Pty Ltd. Menekúe, R. (2005). Her ùey Dahil Sisteminin ve Sistemden Faydalananlar Açsndan Etkilerinin Otel Yöneticilerinin Gözünden De÷erlendirilmesi (Marmaris Örne÷i). Ekonomik ve Sosyal Arastrmalar Dergisi, Bahar 2005, (1), 97-124 Ministry of Trade and Tourism, Republic of Srpska (2011). Investment Opportunities in Tourism Sector of the Republic of Srpska, Banja Luka, Bosnia-Herzegovina. —. (2014, January 21). Tourism Master Plan Jahorina, Bosnia and Herzegovina. Sarajevo: Hypo Alpe-Adria Consultants, Retrieved January 21, 2014 from

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http://www.vladars.net/sr-SP-Cyrl/Vlada/Ministarstva/MTT/PPP/ Documents/TOURISM%20MASTER%20PLAN%20JAHORINA.pdf Nižic, M. K., & Drpic, D. (2013). Model for Sustainable Tourism Development in Croatia, Tourism in Southern and Eastern Europe, 2nd International Scientific Conference. University of Rijeka, Faculty of Tourism and Hospitality Management, 159-173. Nurkovic, R. (2009). Influence of Tourism on the Regional Development of Bosnia and Herzegovina. International Journal of EuroMediterrranean Studies (IJEMS). 2 (2), 202-214. Ozellestirme Idaresi Baskanligi. (2014, January 21). Basn Açklamalar. Retrieved January 21, 2014 from http://www.oib.gov.tr/duyuru/2001_temmuz_aralik.htm. Ritchie, J. R. B., & Crouch G. I. (2010). A model of destination competitiveness/sustainability: Brazilian perspectives. Public Administration Review, 44(5), 1049-66. Soyak, M. (2013). Uluslarararas Turizmde Son E÷ilimler ve Türkiye’de Turizm Politikalarnn Evrimi. The Journal of Marmara Social Research, 4, 1-18. T.C. Kültür ve Turizm Bakanl÷. (2011). Turizm Verileri. Retrieved December 11, 2013, from http://www.kultur.gov.tr/Eklenti/2140,turizmverileripdf.pdf?0. T.C.Kültür ve Turizm Bakanl÷. (2007a). Türkiye Turizm Stratejisi 2023. Retrieved from izka.org.tr/files/planlama/1_Ust_Olcekli_Plan_Programlar/Turkiye_Tu rizm_Strateji.pdf. T.C. Kültür ve Turizm Bakanl÷. (2007b). Türkiye Turizm Stratejisi 2023 Eylem Plan 2007-2013. Kültür ve Turizm Bakanl÷ Yaynlar – 3085, Ankara, Türkiye. T.C. Kültür ve Turizm Bakanl÷ Yatrm ve øúletmeler Genel Müdürlü÷ü. (2012, July). Türkiye’de Turizm Sektörüne Sa÷lanan Teúvik ve Destekler. Ankara. Tezcan, K., Karadeniz, E., Kandr, S. Y., and Önal, Y. B. (2008). Evaluating the Applied Tax Policies for Development of Turkish Tourism Sector. IV. Lisansüstü Turizm Ö÷rencileri Araútrma Kongresi, 827-851, Antalya, Türkiye. Toker, B. (2007). Türkiye’de Turizm Sektörü TesviklerininDegerlendirilmesi. Yönetim ve Ekonomi, 14/2, 81-92. Turizmhaberleri. (2013, January 5). Turizmin Gecmis Gunlerinde Turizm Bankas A.S. Retrieved January 5, 2013 from http://www.turizmhaberleri.com/haberayrinti.asp?ID=24457. Turkish Association of Travel Agencies (2015; April 28). Retrieved April

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28, 2015 from http://www.tursab.org.tr/en. Turkish Ministry of Culture and Tourism (2015; April 28). Retrieved April 28, 2015 from http://www.kultur.gov.tr/EN,35054/culture.html. Turkish Statistical Institute (2015; April 28). Retrieved April 28, 2015 from http://www.turkstat.gov.tr/PreTablo.do?alt_id=1072. Turofed (2010). Turizm Raporu, 1(2). Türkiye Otelciler Federasyonu Yaynlar, Istanbul. TURSAB (2014; January 21). Dünden Bugüne Seyahat Acentalar. Retrieved January 21, 2014 from http://www.tursab.org.tr/tr/seyahatacentalari/dunden-bugune-seyahat-acentalari_501.html. UNWTO. (2014). United Nations World Tourism Organisation Tourism Highlights 2013 Edition. Retrieved on April, 28 2015 from http://dtxtq4w60xqpw.cloudfront.net/sites/all/files/pdf/unwto_highlight s14_en_hr_0.pdf. USAID. (2011). Sector Statistic Report: BH Foreign Tourist Arrivals. FIRMA Consortium BH, Sarajevo, Bosnia and Herzegovina. —. (2006). Sector Statistic Report: An Analysis of Sarajevo, Herzegovina and Krajina Tourism Regions and Recommendations for Product Development, Marketing and Destination Management. Emerging Markets Group, Ltd, Arlington, VA, USA. Vakiflar Genel Müdürlü÷ü. (2014, Jan 21). Restore Edilen Vakf Kültür Varlklar. Retrieved January 21, 2014 from http://www.vgm.gov.tr/sayfa.aspx?Id=25. Var, T. (2014, January 21). The Role of Coastal Tourism in Turkish Tourism Development: A Historical Perspective. Retrieved January 21, 2014 from http://web.deu.edu.tr/smbm/turgut%20var.pdf . World Travel and Tourism Council. (2012). Travel and Tourism Economic Impact 2012, Bosnia and Herzegovina. London, UK. Yldz, Z. (2011). Turizmin Sektörünün Geliúimi ve østihdam Üzerindeki Etkisi. Suleyman Demirel University The Journal of Visionary, 3(5), 54-71.

CHAPTER SIXTEEN THE ABANDONMENT OF THE POVERTY-DEBT CYCLE BY DINT OF FISCAL POLICY: THE MODEST BOSNIA AND HERZEGOVINA EXPERIENCE ZEHRA MAHMUTOVIû AND UGUR ERGUN

Abstract: The 2008/2009 crisis began in developed countries (such as the United States and the United Kingdom) after the failure and merging of numerous financial institutions, bailout of banks, and downturns in stock markets, but this crisis soon affected most countries around the globe. As a result, many developing countries have been caught in a cycle of poverty and debt, which impairs their long-term stability and economic growth. Bosnia and Herzegovina (BH) is also no exception. Literature agrees that fiscal policy growth support is significantly hampered by the initially high levels of public debt. The “driver’s seat” of Bosnia and Herzegovina’s fiscal coordination had long been occupied by the international community. In 2008, as the response to the lack of fiscal responsibility, international organisations advised the Fiscal Council of Bosnia and Herzegovina. The primary responsibility of this Council is to set a fiscal target that will support long-term sustainability and a development strategy. However, the current situation in BH is far from this idea of sustainability and continuous economic development. The objective of this study is to evaluate Bosnia and Herzegovina’s existing fiscal policy in light of relevant literature and to define modes that can improve the crucial macroeconomic indicators. Keywords: Fiscal policy, debt, IMF, World Bank, unemployment, stand-by arrangements, developing.

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Introduction The 2008/2009 fiscal crisis that began in developed countries (such as the United States and the United Kingdom) after numerous financial institutions failed and merged, resulted in bank bailouts and stock market downturns. Soon, this crisis took hold in most countries around the globe. The key lesson from this crisis is that it is relatively hard to restore confidence in financial markets once impaired. As a consequence, many developing countries have been caught in a cycle of poverty and debt that impairs their long-term stability and prevents sustained economic growth. Bosnia and Herzegovina, a SEE developing country, has not avoided this plague. In the years following the fiscal crisis, the trade and budget deficits of Bosnia and Herzegovina have grown continuously. This combination would represent a real threat to any economy, especially a developing one. Although the public debt of Bosnia and Herzegovina seems to be covered, and according to the Maastricht Treaty’s conditions, Bosnia and Herzegovina is far from its outstanding debt limit. BH has been unable to finance itself even with a deficit equal to 3.9 percent of GDP from 2009 to 2012. As a result, BH has had to search for outside financial support. A lack of planned movements, incompetent government structures, and a failure to implement suggested reforms has led to the sore reality of excessive public spending, growing debt, and endemic unemployment. The aforementioned situation doubtlessly indicates the instability of the financial system in Bosnia and Herzegovina, which has significantly contributed to political interference in economic decision-making. Furthermore, Bosnia and Herzegovina has justified to the public the inevitable need for policy reforms at the state level. For a long time, no BH institution was in control, as the local fiscal coordination was in the hands of the international community. In 2008, in response to the fiscal crisis, international organisations advised the Fiscal Council of Bosnia and Herzegovina. The primary responsibility of this Council is to set an overall fiscal target that will support long-term sustainability and a development strategy. However, the current situation in Bosnia and Herzegovina is far from this idea of sustainability and continuous economic development. The objective of this study is to evaluate Bosnia and Herzegovina’s existing fiscal policy in light of relevant literature and to define modes that will perhaps improve the nation’s crucial macroeconomic indicators. This

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study attempts to adapt global experiences to local circumstances which would perhaps speed up the abandonment of the poverty-debt cycle in which Bosnia and Herzegovina has long been trapped. The next section provides a review of the literature regarding, not only the poverty-debt cycle common around the globe, but also the government policies used to mitigate the recent crisis’ effects. Furthermore, the second section considers the research, and makes suggestions regarding public debt management and unemployment. The third part of the chapter presents local experiences of global turbulence and provides an overview of Bosnia and Herzegovina’s fiscal policy and debt. The final part briefly concludes the discussion by suggesting further improvements and further directions for study.

Literature Review Strive to Develop Around the world, economic development is the principal challenge of the 21st century. Most countries have “stop and go” economic growth, as described by Quiggin (2000), as characterised by periods of strong growth followed by huge economic drops. These downturns would be negligible if they did not recur so often. In 2007, Pease examined controversies surrounding the issues of poverty and development, and listed population growth, corruption, and excessive government spending as the main obstacles to development. The international financial crisis has brought into focus on the indisputable reliance of developing markets on foreign and domestic financing (OECD Publication, 2002). Economies rely heavily on credits in order to bridge the gap between income and expenditure. This question is frequently asked: How did the poorest nations acquire such massive debt—recently estimated to amount to more than 700 billion USD? Answered as simply as possible, the developing nations borrowed more than they could afford, failed to manage large portions of it, spent a lot of it unadvisedly, and lived well beyond their means. The tendency of debt to accumulate over time explains the continued significance of Adam Smith’s axiom, “Bankruptcy is always the end of the great accumulation of debt.” The expeditious rise in public indebtedness no longer pertains only to developing nations. Reinhart & Rogoff (2010) found that the relationship

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between growth and public debt is notably identical across a sample of both emerging and advanced economies.

Nations’ Extensive Indebtedness The story of developing nations’ extensive indebtedness starts with the IMF and World Bank, which suggested that those nations should borrow the required capital in order to recover and avoid sharp economic drops; these nations had to borrow heavily in order to survive. Many observers have attributed hostile intent to the IMF, which was described as an extension of the United States (U.S.), and of capitalism in general. However, when capitalist market conditions are even slightly present, then sustainable economic development is simply impossible (Pease, 2007). The borrowing costs on public debt are defined by a number of factors, the most dramatic of which are repayment problems and the overvaluation of an economy’s repayment capacity (Poterba and Rueben, 1999). Hudson (2000) sketched the history of economic thought regarding the selfexpanding growth of debt in excess of the ability to repay it. Interestbearing debts and unattractive policies are causing social problems. While debts grow exponentially, the economy is growing less rapidly. The irrefutable fact is that “debts mount up according to their autonomous selfexpanding principles regardless of economic conditions” (Hudson, 2000).

Passport to Join the Underclass Economic stagnation and inflation cripple economies and result in high levels of foreign debt, and low employment rates. Unemployment represents a threat to society that cannot be ignored; it is a passport to join the underclass. In practical terms, we are as far from an applicable solution as we were when Blackburn (1999) mentioned three excuses for high unemployment: blaming the victims, blaming the government and blaming unavoidable economic processes. The commonality of the unemployment experience is the most striking feature of the last three decades. However, there have been significant differences in its severity and extent. The fundamental question is not why the rate of job creation in Europe has been low but why this rate has not been consistent with population growth (Eatwell, 2000). With the aim of prescribing an effective cure to fight Germany’s unemployment problem, Funk (2001) concluded that an economic policy can be fruitful and reduce not only cyclical, but also structural unemployment, but only if the labour

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market and welfare reforms are emphasised. Otherwise, the contraindications of the prescribed cure will appear. Similarly, evidence from Turkey, an emerging market, suggests that policy makers should divert attention to nonmonetary policies in order to hamper high and persistent unemployment (Berument, Dogan and Tansel, 2006).

Financial Crisis as a Test Opportunity During the recent crisis, Jurþiü (2010) claimed that a financial crisis represents a real opportunity for testing economic theories and policies in practice. There is generally a “lack of consensus” about the effects fiscal policy may have during a crisis (Courtois, 2009; Pelinescu and Caraiani, 2010; Midthjell, 2011; Kollman, Roegeber, and In’t Veld, 2012), but the recent economic crisis stimulated various policy responses globally (Fischer and Justo, 2010). Debrun and Kapoor (2010) concluded that every government has to engineer its policies and provide the appropriate fiscal stimulus in times of crisis.

Simple in Books, Failure in Reality Fiscal policy growth support is significantly hampered by high initial levels of public debt. Thus, the common forms of fiscal stimulus (including tax cuts and increased spending) contributed to an increase in government deficits and were far from their major aim of combating the recent global crisis (Baldacci, Gupta and Mulas-Granados, 2010). Fiscal expansion and stimulus looks simple in textbooks but often fails in reality (Pelinescu and Caraiani; 2010). The avoidance of policy mistakes that seriously contributed to the severity of past downturns (e.g. the Great Depression in the 1930s) is the main focus of policy makers today (Alcidi and Gros, 2011). The recent crisis denoted the beginning of new trends in economic policy setting and the politics of public debt (Streeck, 2013), as it was “a quite unprecedented episode in terms of its severe and worldwide implications” (Tagkalakis, 2012).

Hunting an Optimal Fiscal Stimulus The absence of severe policy responses is bringing us into a state in which we collectively hope for a miracle to happen (Quiggin, 2000). De Mendonça and Duarte-Nunes (2011) concluded that the probability of

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another crisis can be considerably reduced if fiscal policymakers are oriented toward controlling the public-debt-to-GDP ratio. Fiscal policy should be in focus at all times, not only when monetary policy lacks effectiveness (Chowdhury and Islam, 2011), as both the quantity and composition of government spending have important effects on growth, poverty and inequality.

Local Experience of Global Downturns Recently, Bartlett and Prica (2012) analysed why some SEE countries have been deeply affected while others have had only light downturns, and concluded that the countries that were less integrated into the global market were also less affected by the recent crisis (Bartlett and Prica, 2012). Thus, while struggling with the negative consequences of the fiscal crisis, we have to be careful to not lose sight of Bosnia and Herzegovina’s internal problems (Kumaliü, 2011): the chronic deficit, excessive and constantly growing unemployment, a decline in FDIs, corruption, the slow pace of reform, etc. If the policy makers in Bosnia and Herzegovina want to foster a brighter future, they must primarily manage fiscal policy (Jankulov, 2007). In 2006, Kanda discussed the trade-offs between monetary and fiscal settings, and concluded that in Bosnia and Herzegovina’s case, credit flows and fiscal stances significantly affect the trade balance. The main paradigm from his study was that achieving the desired correction in the external debt is possible only through a policy measure that redirects credit flows from households to enterprises. This study goes a step further, as it incorporates Bosnia and Herzegovina’s other macroeconomic variables into the model and promotes solutions to cut the external deficit and strengthen fiscal policy, aside from those suggested by Kanda (2006). In short, the study tries to determine the macroeconomic costs of increased state indebtedness.

Fiscal Policy and Debt during the Financial Crisis: Bosnia And Herzegovina’s Experience In the second half of 2008, the macroeconomic conditions in Bosnia and Herzegovina showed significant declines, only partially due to the global financial crisis. The nation’s structural and political turbulence contributed greatly to its declines in key macroeconomic indicators. The

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unemployment rate continuously increased, public spending became excessive, and the account deficits deepened. Table 16-1: Macroeconomic indicators Nominal GDP (in million BAM)

16,9 28.0

19,4 99.8

21,9 81.3

24,8 97.4

24.2 02.0

24,7 72.8

25,6 80.1

25,6 54.3

23,6 29.5

Real growth rate (%)

3.9

5.5

6.0

5.6

-2.8

0.7

1.0

-1.1

0.8

Unempl oyment rate (% of labour force)

44.6

44.2

29.0

42.1

42.2

43.6

43.8

44.1

44.5 5

Inflation , CPI

3.6

6.1

1.5

7.4

2.0

-0.4

3.1

2.1

-1.2

Source: IMF and Trading economics as of March 2014

Since BH authorities have failed to manipulate these issues that have long prevented prosperity and the further development of the economy, the assistance of international organisations was inevitable. Bosnia and Herzegovina’s unique political and economic structural limitations consisted of two entities (FBH and RS). The FBH is further divided into ten cantons, each of which possesses its own constitutions and governance, which has resulted in the “existence of overlapping competencies” (Mirašþiü, 2011). This has negatively affected every sector of the economy. The excessive decentralized decision-making model and the lack of unique economic policies at the state level have hindered Bosnia and Herzegovina’s recovery from cyclical economic for years (see Table 16-1 above). Undergoing the economic transition process from a closed-command economy into an open-market economy in the past two decades has imposed great barriers on BH, out of which the constant growth of structural unemployment is the most striking. The fiscal sector in Bosnia and Herzegovina has been continuously out of the desired stabilising workflows since the end of the war in 1995 (Mirašþiü, 2011). Public spending has been increasing heavily as a result

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of the complex governmeent structure an nd a lack of cconcrete devellopmental goals. Thee consequencce of this uncontrolledd spending was an unsustainablle and insufficient budget, both before aand after the recession. r In 2007, pubblic expendituures began to cross the goveernment reven nue limit; causing signnificant deficits (see Figurees 16-2 and 166-3). The defiicit traces back to BH authorities’ decision d to fin nance importss from externaal sources (the IMF annd other interrnational orgaanisations) ass due to a deecrease in exports andd an inability to finance trade independ ndently so as to attain relative budggetary stabilitty. Mirašþiüü (2011), afterr analysing th he current maacroeconomic situation in BH, direccted his attenntion toward the t stand-by aarrangements with the IMF and staated that the cyclical, c but modest, m grow wth of real GD DP in BH has been reccorded just affter each SBA A placement w was imposed. This T kind of instant heelp not only postpones p imp plementing a long-term sollution but also concealls the current macroeconom mic situation. It further slo ows down the already sslow BH econnomic cycle (M Mirašþiü, 20111). Figure 16-2: B BH revenues & expenditures (2007-13) ( in miillions BAM

Source: Bosnnia and Herzegoovina MAU web bpage, Feb. 20114.

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BH governmennt surplus/deficiit (2007-2013) iin millions BAM M Figure 16-3: B

Source: Bosnnia and Herzegoovina MAU web bpage, Feb. 20114

Bosnia aand Herzegoviina fails to prroduce new vaalues (Mirašþiiü, 2011); rather, it iss exhausting the existing one and, coonsequently, failing f to implement ssignificant strructural, instiitutional, and economic reeforms to ensure a return to the path p of contin nuous develoopment. The estimated e model in a 2006 IMF sttaff report ex xamined Bosnnia and Herzeegovina’s credit flowss, fiscal policyy, and extern nal deficit andd it showed th hat fiscal revenue andd expendituress have significcant effects onn trade balancce as “one percent of G GDP in fiscaal expendituree has an alikke effect on the trade balance as a curtailment of one perceent of GDP inn overall cred dit to the private secttor” (Kanda, 2006). Volltaire (1764) defined thee “art of government” as the process of attemp pting to take tthe maximum m possible value from one group annd direct it to o those in neeed. Howeverr, the BH government has sought too take equally y from everyoone (including g those in need) in orrder to strenggthen the prosperous few, which inevittably has resulted in w widening the rich-poor r gap and loweringg living standaards. This income ineqquality has fuurther slowed Bosnia and H Herzegovina’s already slow reform ms. Social transfers reppresent the best measuure of goveernments’ responsibilitty toward theiir vulnerable citizens. c The overall sociall transfers (see figures below) in Bosnia and Herzzegovina amouunt to about 14 percent of its GDP (UNDP, 2013), the majorrity of which goes to penssions and health care services. How wever, a largee proportion oof these transffers go to noninsurancce benefits. They includ de veterans’ benefits, ch hild care allowances, and social assistance. For comparisoon, social traansfers in

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Croatia and Serbia in 2013 were 26 percent and 32.9 percent of GDP, respectively.

Conclusion Bosnia and Herzegovina’s strange logic is that every increase in deficit is an excuse to request a new loan package instead of to conduct reforms. However, these missed reforms, policy errors, and wasted years will have a cost, which leads to the question of whether we have the right to spend future generations’ revenue. Why are stand-by arrangements considered the only treatment to repair Bosnia and Herzegovina’s fiscal problems? The hypothesis that “in times of crisis every country becomes hostage to its past performance” has been proven many times in Bosnia and Herzegovina (Hodžiü, 2012). This nation has long avoided dealing with its crucial societal problems, and it has gone to great lengths to do so. Everyone is aware of the problems, but we have not yet begun to fix them (Sirota, 2006). Lasting unemployment, other than corruption, is the most striking developmental phenomenon that requires a solution, and it has recently provoked massive demonstrations throughout the state. Theory suggests that it is important to concentrate on the center of the problem and to fight unemployment directly instead of focusing on growth and hoping that the unemployment problem will consequently be solved. Job-seekers should be supported within their own country; the solution is not to deport valuable human assets to those countries that recognize BH citizens’ potential. During a crisis, especially a very intense one, no universal set of actions can keep an economy completely isolated from shocks: an optimal fiscal policy in such circumstances is part art and part science. Long ago, in 1732, Fuller said, “Debt is the worst poverty,” and developing nations’ economic situation is proving this axiom all over again. Thus, the most appropriate response to a financial crisis in a developing economy, such as Bosnia and Herzegovina, is not to wait for the crisis to pass but to harmonize fiscal, monetary, and other governmental policies.

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A 4000-year overview. Journal of Economic Studies, 27(4/5), 344-363. Jankulov, I. (2007). Is the Fiscal Council the magic solution? Open Society Fund of Bosnia and Herzegovina, Policy development fellowship program. Jurþiü, Lj. (2010). Financial crisis and fiscal policy. Economic overview, 61, 317-334. Kanda, D. (2006). Credit Flows, Fiscal Policy, and the External Deficit of Bosnia and Herzegovina. IMF Working Paper 276. Kollman, R., Roeger, W., & In’t Veld, J. (2012). Fiscal policy in a financial crisis: Standard policy versus bank rescue measures. American Economic Review: Papers & Proceedings 102 (3), 77-81. Kumaliü, J. (2011). Fiscal Policy in time of Financial Crises. Journal of Economics and Politics in Transition, 28. Midthjell, N.L. (2011). Fiscal policy and financial crises - what are the actual effects of fiscal policy?. Norges Bank Economic Bulletin. Mirašþiü, G. (2011). Current Economic situation in Bosnia and Herzegovina. Journal of International and Global Studies, 3(1), 32-46. OECD (2002). OECD Public Debt Markets- Trends and recent structural changes. OECD Publication. Pease, K. S. (2007). International Organisations: Perspectives on Governance in the Twenty-First Century. PE, Inc. New Jersey. Pelinescu, E., & Caraiani, P. (2010). Fiscal policy in the context of the Economic crisis. Romanian Journal of Fiscal policy, 1(1), 1-21. Poterba, J. M., & Rueben, K.S. (1999). Fiscal rules and state borrowing costs: Evidence from California and other states. Public policy Institute of California. Quiggin, J. (2000). Unemployment: Still hoping for a miracle? International Journal of Manpower, 21(5), 374-383. Reinhart, C.M., & Rogoff, K.S. (2010). Growth in a time of debt. American Economic Review: Papers & Proceedings, 100, 573-578. Sirota, D. (2006). Hostile takeover: How Big Money and Corruption have conquered our government and how we take it back. New York: Crown publishers. Streeck, W. (2013). The politics of public debt. MPIfG Discussion Paper 13/7 Tagkalakis, A. (2012). The effects of financial crisis on fiscal positions. Bank of Greece Working Paper 145.

CHAPTER SEVENTEEN THE MICROFINANCE TALE: THE BRIGHT AND DARK SIDES OF THE NARRATIVE BOSNIA AND HERZEGOVINA EXPERIENCES ZEHRA MAHMUTOVIû AND ALI COSKUN Abstract: In recent years, microfinance institutions have gained great attention and were described as the most “attractive” mode of financing for developing nations. Inspired by a quote that, “You start thinking about the beginning once you arrive at the end,” this study attempts to rewind and provide a brief revision of the microfinance system within the developing settings of Bosnia and Herzegovina. The whole story traces back to the deepest convictions of Muhammad Yunus, a Bangladeshi banker, that the right to get a loan should be included in the sequence of basic human rights as well as his contribution to the poverty reduction challenge through the establishment of Grameen Bank (the bank for the poor) in 1976. Today, when we all are witnesses that his idea was pretty sustainable, and are tirelessly discussing it as the greatest innovation of the last century, there is a necessity to draw a comparison between the initial idea and its realisation, and decipher to what extent the realisation is consistent or not. In this study, we inspected whether microfinance institutions have “turned back” from their original mission of providing financial support for small entrepreneurs, based on the experiences of the clientele in Bosnia and Herzegovina, a developing country in Southeast Europe (SEE). Furthermore, it seeks answers for the open question: has the initial idea of fighting poverty become a stumbling block, making the poor even poorer, or a work-only solution for the enormous rate of unemployment in Bosnia and Herzegovina?

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Keywords: Microfinance, Microfinance Institutions (MFIs), Microcredit Organisations (MCOs) poverty, debt, developing, small and medium-sized enterprises, Bosnia and Herzegovina.

Introduction In the years following the “Great Recession,” the microfinance system started to flourish rapidly and thus very soon occupied the financial stage worldwide, especially in developing nations, and became “a very attractive way of financing” (Smolo, 2011, p 85). Microfinance organisations have been introduced in order to secure permanent, sustainable funding for the poor, who are prevented from getting credit support from commercial banks because they do not meet the strict criteria, credit history and other relevant conditions. Furthermore, these organisations have been established for the reason that formal credit institutions (capital markets) and informal lending systems do not contribute much to the growth of micro enterprises (Mishra, Mall & Mishra, 2013). The significance of micro enterprises together with medium-sized enterprises (SME) is immeasurable in the context of developing countries such as Bosnia and Herzegovina. The microfinance story finds its roots in the deepest convictions of Muhammad Yunus, a banker from Bangladesh who advocated that the right to get a loan should be included in the sequence of basic human rights (Yunus, 1999), and his contribution to the poverty reduction challenge through the establishment of Grameen Bank (the bank for the poor) in 1976. In short, microfinance, microcredit or microloans have been introduced in order to rescue individuals deeply caught in the poverty cycle. Although often used interchangeably, between the microfinance and microcredit concepts significant differences exist. Microfinance is a broader term than microcredit and refers to a set of financial services including loans, savings, insurance and money transfers directed at lowincome and unemployed individuals. Microcredit is a subset of microfinance and refers more specifically to the procedure of providing capital for small businesses and supporting them to become self-sufficient and financially sustainable. The European Commission (2007) defined microcredit as a loan to the amount of 25,000 Euro intended for the financing of new or existing small and medium-sized enterprises. But this upper limit of a microcredit is individually defined in every country, and thus, the maximum allowable amount of credit is much lower in developing countries than is defined by the European Commission. For the sake of comparison, the limit in Bosnia and Herzegovina is almost 80%

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less and amounts to 10,000 BAM (approximately 5,000 EUR). Today, when we all are witnesses that Yunus’s idea introduced more than twenty years ago was pretty sustainable and are tirelessly discussing it as the greatest innovation of the last century, there is a necessity to draw a parallel between the initial idea and its realisation, and decipher to what extent that the realisation is consistent or not. Relatively sparse is the list of fields that simultaneously emphasise economic and social performance intensively, as the microfinance sector does (Tulchin, 2003); the social performance of a microfinance institution (MFI) is nothing other than “truth in advertising” (Hashemi, 2007). But, the literature written thus far, almost four decades from the foundations of this poverty alleviation tool, continuously advocates that most of the MFIs “turned back” from their original mission of providing financial support for small entrepreneurs; thus, profit goals have overcome the social goals considerably. This study attempts to draw a parallel and determine whether this initial idea of fighting poverty through providing microcredits brought the dark reality of making the poor even poorer, or if this statement is nothing other than a baseless claim. It concentrates on and analyses the microfinance sector within Bosnia and Herzegovina (BH), as a developing country, in which fighting poverty through microfinance services became a habit of many unemployed citizens.

Literature Review The substantial component of any well-operating economy is the steadiness of its financial sector (Kamhi and Dehejia, 2006). Thus, the literature examining the effects of microfinance sector movements on the entire progress of a state is quite extensive; numerous researches have reached different conclusions, either having positive, neutral or negative impacts (Matul and Tsilikounas, 2004; Dunn, 2005; Demirgüc-Kunt, Klapper and Panos, 2011). MFIs provide services to a thoroughly dissimilar “niche market” (Vanroose and D’Espallier, 2009) and thrive where formal banking is weakened and deficient, with the microcredit sector being a sector characterised by the interest-elastic demand (World Bank, 2008). The customers are the “essence of microfinance, and what defines the resilience of an MFI is the resilience of the clients they are serving” (Gonzalez, 2011). The microfinance idea was originally a simple one; currently, the microfinance sector is a far ranging and dynamic sector promising rectification of market failures through the improvements of capital distribution and providing chances for the needy (World Bank, 2008; Cull, Demirgüç-Kunt and Morduch, 2009; Vanroose and D’Espallier,

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2009; Brune, 2009; Karlan and Goldberg, 2011). The prosperity of a developing economy is significantly accelerated through supporting the establishment of small and medium-sized enterprises; but the core problem that SMEs face in transitional countries is assessing the primary capital level necessary to finance the start-ups (Džafiü, Rovþanin and Gržiniü, 2008). Providing credits to small businesses is relatively risky and involves a high degree of insecurity, high failure rates, and various economic fluctuations and market changes. Literature attributed the microfinance sector as the leading force behind small and medium-sized enterprises (Džafiü et al., 2008); the best way of transforming the unemployed into micro-entrepreneurs (Welle-Strand, Kjøllesdal and Sitter, 2010) and as a sector that balances financial and social goals simultaneously (Halilbašiü and Crnkiü, 2011). The primary attributes ascribed to the microfinance sector were “humanitarian and philanthropic,” but eventually social, political and economic aspects have gained greater attention (Valadez and Buskirk, 2011). “What once was motivated largely and solely by the development and poverty reduction paradigm is evolving into a global industry increasingly driven by a commercial/financial paradigm” (Brau and Woller, 2004). In the sphere of microfinance, of vital importance is to look beyond the “ecomarket” sphere and scrutinize the societal context of it (De Martinez, 2011); influence beyond the client base is a real challenge (Welle-Strand et al., 2010). The economic theory in the Economics of Microfinance advocates a broad list of microfinance bright sides, although the rigorous evidence that can serve as valid proof doesn’t exist (Khawari, 2004; De Aghion & Morduch, 2005; Chowdhury, 2009). Bateman and Chang (2009) believe that microfinance may actually be “undermining attempts,” “a case of bad medicine,” providing only an instant cure but in a longer time frame having significant contraindications. The accent was long on the descriptive theory building rather than on the theory examination (Phan, 2009). Rosenberg (2010) asked a relatively simple question: To what extent do the individual antipoverty anecdotes represent the general experience of the rest who have been using microloans and other micro services, and do they at all? Today’s microfinance echoes the past in many ways (Roodman, 2012) and is a “susceptible bubble” (Wiesner and Quien, 2010; Mujkoviü, 2010) that already burst in Morocco, Pakistan, Nicaragua, India and in Bosnia and Herzegovina. When the bubble will burst again remains to be seen or avoided.

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Microfinance in Developing Settings: The Case of Bosnia and Herzegovina Microcredits as a modest but, in comparison to bank loans, relatively fast way of obtaining financial support in order to fill the “holes in your budget” in the short term, or to start your own small enterprise as a more permanent solution to ample unemployment, flourished in Bosnia and Herzegovina very quickly. It seems that BH was a very fertile ground for implementation of the microfinance project since it flourished relatively quickly and MFIs in Bosnia and Herzegovina became quite financially sustainable in a relatively short period of time. The institutions offering microloans in Bosnia and Herzegovina are registered as microcredit organisations (MCOs) operating as nonprofit microcredit foundations (MCFs), for-profit microcredit companies (MCCs) and commercial banks. MCOs’ main activity in BH is providing microloans for citizens in need in order to engage in entrepreneurial activities (Dunn, 2005). They operate as commercial entities with limited liability or joint-stock companies. The minimum amount of initial capital for microfinance organisation establishment is 500,000 BAM (250,000 Euro). The management bodies within an MFI are an assembly, supervisory board, administration (director and executive directors) and an audit board consisting of at least three members elected by the supervisory board. In Bosnia and Herzegovina there are 24 registered MFIs, out of which 20 are nonprofit MCFs and 4 are for-profit MCOs. In total, 1,779 workers were employed in microfinance organisations in Bosnia and Herzegovina during 2008, as compared to 2010, in which the number of employees decreased and amounted to around 1,588. By the end of the 2013, the number of employees within the microfinance sector further decreased around 9 percent, and in the Federation of Bosnia and Herzegovina (FBH), it amounted to 1,416 employees. Descriptive data derived from an analysis oriented toward the microfinance program in Bosnia and Herzegovina advocate prosperity, incentives toward further growth and optimism for the forthcoming period (ýiþiü and Šunje, 2001); in brief, “dynamics” would be the summed description of the microfinance sector in BH (Halilbašiü and Crnkiü, 2007). Bosnia and Herzegovina is a transitional country seeking to get back on track toward growth (Smolo, 2011). A parallel between microfinance, poverty and education was tested on a sample derived out of

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the developing Bosnia and Herzegovina community. The investments appear to be “lumpy and loans too small in themselves” to establish or expand a business, while “informational externalities” are causing exclusion from nondiscriminatory credit access (Hamad, 2012; Augsburg, De Haas, Harmgart and Meghir, 2012). Furthermore, the level of education and the purpose for which the microloan was requested are highly correlated, highlighting the missing “know-how” of the sample. In essence, how wide and where the supply-demand gap lies within a developing economy such Bosnia and Herzegovina has been the research focus of Matul and Tsilikounas (2004). Although a number of MFIs in BH are highly exceeding the average of the rest of the Balkan Peninsula, the abundance and diversity of services are the cause of discontinuities in progress (Matul and Tsilikounas, 2004). Recently, Armendáriz and Labie (2011) confirmed that generally a mismatch exists between the limited microfinance offers and the needs of highly heterogeneous low-income individuals. Karim, Tarazi and Reille (2008) concluded that Islamic microfinance represents the confluence of two rapidly growing industries (microfinance and Islamic finance) and has a great potential to merge the Islamic social principle of caring for the less fortunate with microfinance’s ability to offer financial support for those people. Along the same line, Smolo (2011) claimed that in the microfinance sector in Bosnia and Herzegovina, there is room for Islamic microfinance due to the fact that the most common religion in this area is Islam and one of the reasons why citizens do not apply for microcredit is the noncompliance with sharia (moral code and religious orders of Islam) and thus suggested several ways to meet this demand. A second mismatch lies between reality and the well-prepared MFI mission statements (Molenaar, 2009). Recently, in Hamad and Duman (2013); in evaluation of the microcredit programs in Bosnia and Herzegovina through the Porter’s Diamond Model, it has been suggested that in order to improve the efficiency of the microcredit sector, a unified banking agency at the state level should be established.

How do Microfinance Institutions fit Into a Post-Conflict Environment? Bosnia and Herzegovina is a relatively small Southeastern European economy that confronts the dual problem of recovering as a wardevastated country and introducing transitional liberal market reforms. The microfinance sector was highly improved in BH in the mid-1990s and after the signing of the Dayton Peace Agreement in 1995. In this period of

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time, BH was instantly faced with major reform needs and growth challenges. The World Bank supported the microfinance sector via its finance program, the so-called local creativity project. This project qualified and supported a large number of microfinance institutions in Bosnia and Herzegovina. Since then, MFIs have provided resources to numerous households and small enterprises that might otherwise have remained cut off from any official support. Whether the microfinance model in post-war Bosnia and Herzegovina is an instantaneous relief or in a longer time frame encourages sustainable socioeconomic growth has been discussed repeatedly. Bateman (2007) claims that little evidence exists for the needful “transformative capacity” that assures ongoing poverty mitigation but also continuous socioeconomic developments.

Regulation and Supervision of Microfinance Institutions in Bosnia and Herzegovina The state administration of Bosnia and Herzegovina has delegated power to its two constituent parts, the Federation of Bosnia and Herzegovina (FBH) and Republika Srpska (RS), to regulate the MCOs. In the FBH, the Ministry of Social Policy, Displaced Persons and Refugees is obliged to define the rules, but the fact is that it possesses relatively poor knowledge about the financial sector in general. In the RS, the same task is placed on the Ministry of Finance. Neither of the ministries actually supervises MCOs; laws are not matching, but there are intentions to harmonise them in the future. Recently the Banking Agency of the FBH was established to provide improvements, safety and quality to the legal frameworks of the banking and microcredit system and is fully competent for regulating MCOs. The far-reaching trend affecting the legal and regulatory environment of microfinance was to create a unified and consolidated mechanism that will shape the country into a “workable economic space”; this trend did not come into reality although many years have passed, as Lyman (2005) concluded in his study. In an evolving economy, the regulation and supervision of MFIs represents a real challenge; Živko and Slijepþeviü (2007) highlighted the importance of competence and improved cooperation among supervisors and regulators in Bosnia and Herzegovina at the state level. Moreover, the “complexity of poverty” causes the inability of microfinance to resolve the poverty problem alone (Van Santen, 2010). The microfinance framework in BH unfortunately is “the legalized looting and ultimate destruction” of the domestic financial

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environment (Bateman, Sinkoviü and Škare, 2012a) and the best proof of “control fraud.”

Problems Facing Microfinance Institutions in Bosnia and Herzegovina Since its introduction around 40 years ago, the microfinance sector has had very productive years and strong growth; however, since the global financial crisis that took place recently in 2010, the sector has been damaged significantly, having strong side effects on its customers. One of the main problems is that some banks, in recent years, entered the market of microfinance organisations and made strong competition in this sector even sharper. The other problem is that various banks and microfinance organisations made their loans very accessible, and almost everyone who applied for a loan received it, which resulted in the departure from the original mission of an MFI and the misuse of loans (Mujkoviü, 2010). A loan can be defined as a tool that can be very powerful when it is available to customers who at least partly participate in the economy (Robinson, 2001). The poorest should be the responsibility of the government or Ministries of Health, Labour or Social Policy (Rosenberg, 2010), rather than the responsibility of MFIs. Loans used by those in extreme poverty and used for non-business purposes will cause more debt, and in the end, the result will be taking new loans just to repay old debt (Robinson, 2001). The microfinance contribution should in fact be considered as a valid antipoverty tool, which from the perspective of Midgley (2008) is most effective when incorporated into a broader set of policies and programs within an economy.

Supporting the Development of SMEs in Bosnia and Herzegovina The insufficient support of the business environment directed toward the growth of entrepreneurship is the main reason for the delayed development in the private sector. The decision to start a business and the density rate are primarily determined, according to research results of Klapper, Amit, Guillén and Quesada (2007), through the quality of the legal and regulatory environment, and the access to finances. The MFIs significantly alleviated the second listed determinant, the financing constraint of microbusinesses in Bosnia and Herzegovina (Hartarska and Nadolnyak, 2007), a country in which there is an obvious need and

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possibility of activating MFIs in the development of rural tourism, the greatest undeveloped domestic potential (Vujiü, 2007). The recommendation is accepting the lessons from worldwide MFI experiences, combined with specific needs of the domestic population (sample included Bosnia and Herzegovina, and Croatia) supported socioeconomically and culturally (Džafiü et al., 2008). Factors that discourage the establishment of small and medium-sized enterprises in Bosnia and Herzegovina besides unfavorable financing conditions are relatively weak state support and the poor protection of the domestic industry. The World Bank listed BH among the last countries of the SEE region in efficiency in the “Doing Business Report” (Šunjiü-Beus, Martinoviü and Veselinoviü, 2008). A recent finding sustains the description of an informal approach to finances as the incubator for formal self-employment in times of development (Demirgüc-Kunt et al., 2011). Access to capital is modeling the intention to develop a business, which is not the case in Bosnia and Herzegovina, where a “general climate of distrust” vis-à-vis financial institutions is present despite a 19-year period of after-conflict recuperation. The informal sector employees are more presumably to become sustainable entrepreneurs, particularly those supported from microloans (Demirgüc-Kunt et al., 2011). Successfully supporting small enterprises is a long process, not a one-time event (Glišoviü and Martinez, 2012); thus, the assumption that access to finances is a key constraint to SME expansion besides the inappropriate regulations and taxes, and the increasingly prevalent corruption, is quite naive. Bateman et al. (2012b) has argued that the microfinance model in Bosnia and Herzegovina has assisted the emerging economy to move to “an unsustainable institutional development trajectory as marked by the deindustrialization, informalization, and infantilization of the enterprise sector.”

Methodology The stepping stone for the continuous development of a country, especially a developing one, is a stable and harmonized financial sector. Years ago, Kamhi and Dehejia (2006) concluded that the steadiness of the financial sector is of crucial importance for an economy. A large piece of the financial sector’s stability in developing nations belongs to the microfinance system. This study aimed to analyse the microfinance system and practices within Bosnia and Herzegovina and consequently contribute to previous similar studies. One of the recent studies described the microfinance sector as a “susceptible bubble” (Wiesner and Quien, 2010; Mujkoviü, 2010) that already burst in Morocco, Pakistan, Nicaragua, India

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and in BH. By implementing this research in developing Bosnia and Herzegovina, we have attempted to foresee if the bubble will burst again and have provided directions that, if applied thoroughly, could deflate the sphere of interest. After collecting and reviewing secondary data from relevant literature and incorporating them into the research as a valuable foundation, the focus was redirected to the primary data analysis. This study goes a step further than the study done by Hamad and Duman (2013) since it also incorporates primary data into the research together with the secondary. More on the primary data collection will be provided in the continuation of this study.

Data Collection The first stage of the research was developing appropriate questionnaires and distributing them to the branches of MFIs in several cities within Bosnia and Herzegovina; the branches most visited were located in the capital Sarajevo, Mostar and Visoko. The versions of the questionnaires were created: one directed to the office staff of MFIs and the other focusing on the clientele. Since they contained pretty concise but, diversified questions, they served the purpose of getting a brief overview of the current situation within the microfinance sector of developing Bosnia and Herzegovina. The questionnaires were based on two parties directly involved in the system and parties that directly benefit from it: employees and clients. Besides that, the focus was on defining the role that MFIs have in supporting the development of small and medium-sized enterprises within a developing country and inspecting to what extent they contribute to the economic prosperity and growth. The second part was getting in touch with, and interviewing, individuals who are employed at managerial positions in MFIs. The collected information regarding their experiences and thoughts about what impact the whole system has on the participants and the community in general, as well as outlines about the main obstacles to further growth they confront, have contributed significantly to the research. Reviewing the existing literature mentioned thus far on the miraculous microfinance sector is quite confusing, and it is hard to connect and find a balance between advocates that blindly believe in the microfinance tale and those who have argued that the whole story is too good to be true and a good marketed trap to poverty-trapped individuals. Thus, the inevitable obstacles while conducting this study were expected.

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Research Questions This study aimed to reconcile these aforementioned conflicting sides and point out the bright and dark sides of the microfinance narrative, all in order to encourage a deeper understanding of the current situation within the sector and promote directions toward improvements. The research questions to which the study sought to find answers are as follows: x In essence, how far is Bateman’s claim that the microfinance industry in Bosnia and Herzegovina is nothing other than a “failed experiment” from the statement that it represents “a best-case scenario for testing the impact of microfinance initiatives” (Bateman, 2007; Welle-Strand, et al., 2010; Džafiü, et al., 2008; Halilbašiü and Crnkiü, 2007)? x How can an MFI program best fit the cradle of other economic and social improvement incentives? x What are the main obstacles to the growth of the microfinance system in Bosnia and Herzegovina? x Is the microfinance sector in BH in conflict with the formal banking sector, do they complement each other; or do they develop irrespectively? x Do unemployed individuals in Bosnia and Herzegovina use microloans to establish an enterprise, or is there another scenario being played out behind the scenes? x To what extent is the geographic distribution of MFIs in BH related to the decision to start a business?

Research Findings The aforementioned inevitable obstacles to conducting this study were confronted in the very beginning. After choosing the sample of interest, being composed of two parties directly benefiting from the microfinance industry (the clientele and employees), we started to distribute the questionnaires online but also in person. This distribution of questionnaires was perceived as a simple way of collecting firsthand information, which will further serve as a valuable basis for the research findings. But things were not to go as planned: Individuals we came in touch with to fill out the questionnaire hesitated in the beginning to participate in the study, and a significant number coldly refused. This skepticism of microfinance pawns heated up our curiosity and was the driving force of the next research phases. The basic paradigm was to

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figure out w what the real situation s withiin the microfinnance sector in i Bosnia and Herzegoovina was andd to what exteent it contribuutes to the red duction in poverty andd unemploymeent levels witthin local com mmunities. In n the end, quite a sattisfactory num mber of questionnaires w were collected d, which together witth the face-to--face interview ws served as tthe valuable secondary s data used in this study. The firstt part of our questionnaire q was w actually sseeking to exp plore how competitive MFIs’ loan offers o are in co omparison to commercial banks b and other inform mal ways of borrowing. As A the resultts suggest, in ndividuals within deveeloping Bosniaa and Herzeg govina still beelieve in and prefer to borrow from m commerciaal banks (Fiigure 17-1). The fact is that the satisfaction with MFIs’ offers is sign nificantly initiially hampereed by the enormous innterest rates annd sparse loan n packages, w which puts the MFIs on the bottom oof borrowing preferences. One of the annswers of thee research questions w was that the microfinance m seector in Bosnnia and Herzegovina is directly com mpeting with the t formal ban nking sector aand has to striv ve to stay competitive in its offers and a services. Microfinance M that puts clieents at the center and taakes into conssideration queestions such aas who are their clients, what do theyy need, how do d they perceiive MFIs and how can microfinance better addreess their neeeds is a neceessity in the case of Bo osnia and Herzegovinaa. Figure 17-1: B Borrowing prefferences of clien nts

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Entrepreneuriall status of clientts Figure 17-2: E

The literrature is continnuously pointting out the im mportance of small s and medium-sizeed enterprise development d and its considderable contrib butions to economic grrowth, but ourr findings sug ggest that the eentrepreneuriaal spirit is quite underddeveloped in the t local comm munities, andd pure consum mption has a consideraable advantagge as comparred to the ddesire to estaablish an enterprise. T The turbulentt socioeconom mic conditionns, inability to t access capital and mutual distruust are leading g factors that diminish amb bitions to become an entrepreneur in Bosnia an nd Herzegovinna. In short, the main problem in B BH is the usaage of microlo oans for smoooth consumptiion rather than to grow w enterprises. Demirgüc-Ku unt et al. (20111) claimed th hat access to capital is modeling the intention to develop d a busiiness, but in th he case of Bosnia and Herzegovinaa, there is a necessity too primarily model m the entrepreneurrial spirit of unemployed individuals. F Furthermore, SMEs in Bosnia and Herzegovina require increaased external support in forrms other than microffinance service. MFIs and initiatives cann definitely contribute c significantlyy in overcomiing the differrences and tuurning the uneemployed into self-em mployed, but finding this common groound in local business developmennt is a long proocess, not a on ne-time event.. Another issue is that MFIs have made m their offfers accessible, and it seems that tthe only criterion of gettin ng a loan is too show the deesire, and thus, the proocedure from requesting a loan l to placinng the money into your pocket is exppeditious. Thee consequencees are relativeely disloyal cliients who could not reesist temptingg offers and borrowed froom two or mo ore MFIs simultaneouusly; thus, theere is a crystaal clear needd to regulate the t MFIs within the sstate and to enncourage them m to come clooser to Yunus’s initial

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idea of helping the poor instead of placing hoops around their necks. In the beginning, there was no law regulating the operations of the financial institutions in Bosnia and Herzegovina. But after such a law was implemented, there were several variations of the law among regions throughout the country; the unregulated economic and financial policies still present within the country represent the main obstacle toward further improvements of the microfinance sector. Socioeconomic stability in BH is achievable through the creation of a well-organised network composed of governmental, business and societal commitments. Besides the unregulated and unadjusted policies and regulations at the state level, MFIs in Bosnia and Herzegovina are facing difficulties in collecting loans, the high risks and decreases in portfolios as the result of the recent global financial crisis. The intensified monitoring of the operations often imposes higher operating costs, which due to the expensive sources of financing (foreign and local) for an MFI, are impediments in attaining financial sustainability. Furthermore, the market saturation (a high number of MFIs and banks are competing in the same field) and the reputational risks (local media disrupts the image of MFIs and their credibility) are problems seeking a solution, as pointed out by the questionnaire participants. Since this study is part of an ongoing research analysing the microfinance system of developing Bosnia and Herzegovina, and its role in supporting the development of small and medium-sized enterprises, it is inappropriate to characterise the whole story about microfinance as positive or negative. Rather, the whole system is a hybrid one, having both positive and negative sides, which if revised could definitely serve the purpose. This study has thus attempted to analyse both sides of the narrative simultaneously, to draw a parallel between them and to point out the constituents of the whole system that definitely require remodeling in the forthcoming years.

Conclusion Microcredits as a modest but, in comparison to bank loans, relatively fast way of obtaining financial support in order to fill the “holes in your budget” in a short time frame, or to start your own small enterprise as a more permanent solution to unemployment, flourished in Bosnia and Herzegovina very quickly. It seems that BH was very fertile ground for the implementation of the microfinance project since it flourished relatively quickly and literature pointed out the developing Bosnia and Herzegovina case as the best microfinance scenario. This study contends with the statement that microfinance institutions have made their offers very

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accessible and attractive to the clients and have significantly moved away from their original mission of fighting poverty worldwide. The clientele of the microfinance system became caught in the trap due to the ease of getting a loan from several MFIs simultaneously and contributed to the multi-borrowing problem, which directly hampers local prosperity. Instead of collecting the first-run revenues from their start-ups, the local microsupported entrepreneurs have to struggle to collect the inevitable installments, which doubtlessly points to the absurdity of fighting poverty through the microloans strategy. This “lend quickly, repent gingerly” axiom certainly requires severe discussion due to the inability to rationally explain the paradox according to which those who are unemployed, and suffering from poverty, pay triple interest as compared to the rest. Intensive development of the Bosnia and Herzegovinan economy through flourishing small and medium-sized enterprises could be supported only through reorganisation and bringing interest rates down to decent and morally justified levels. The inexhaustible philosopher Socrates dressed inconspicuously but very much enjoyed the sightseeing tours in local markets, looking at the goods that were offered. Once, he was asked how he could visit the market every day and not care for the goods offered. Socrates answered as follows: I love to come here and figure out that there is a plentiful range of offers that I do not need to be happy. The Bosnian scenario, analogous to the abovementioned, would be that truly happy is one whom trouble and poverty have not forced to snatch the exposed “macro prices” on the microfinance market stalls.

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LIST OF CONTRIBUTORS

Sead Kreso, Prof. Dr., University of Sarajevo, Bosnia and Herzegovina Kreso, S. (1997). The Money of BH. Sarajevo: Publishing house JEŽ Kreso, S. (2012). World Capitalist Economy and Inflation as a WorldWide Phenomena. Sarajevo: Avery d.o.o. Kreso, S. (2012). Globalisation and the Change of Macroeconomic Management Focus. Sarajevo: Avery d.o.o Predrag Bjeliü, Prof. Dr., University of Belgrade, Faculty of Economics, Serbia Bjeliü, P. (2012). World Trade Organisation and the Global Risks. In Alemano A., et. al (eds.). Better Business Regulation in a Risk Society (pp. 193-206). New York: Springer Science and Business Media. Bjeliü, P., Jaüimoviü, D., & Tašiü, I. (2013). Effects of The World Economic Crisis on Exports in the CEEC: Focus on the Western Balkans. Economic Annals, 58(196), 71-91. Bjeliü, P. (2014). Building Competitiveness and Increasing Trade Potential in the Western Balkans: Economic Policy Making in Preparing for European Integration. In Thomas, M. & Bojicic-Dzelilovic, V. (eds.). Public Policy Reform in the Western Balkans: Case Studies of Actors, Networks and Coalitions (pp. 69-80). Netherlands: Springer Science and Business Media. Ivan Lovrinoviü, Prof. Dr., University of Zagreb, Croatia Lovrinoviü, I. & Nakiü, M. (2012). Trends in Foreign Exchange Reserves Structuring and Management with Special Reference to Croatia. Lovreta, S., Petkoviü, M. & Janiüijeviü, N. (eds.). From Global Crisis to Economic Growth. Which Way to Take? (pp. 349-366). Beograd: Centar za izdavaþku delatnost Ekonomskog fakulteta u Beogradu. Jakovþeviü, D., Lovrinoviü, I., Radoševiü D. (eds.). (2011). Novac i ekonomski rast: Monetarna politika ekonomskog rasta i zaposlenosti ; zbornik radova . Zagreb: Ekonomski fakultet Zagreb. Lovrinoviü, I., ûoriü, T. & Nakiü, M. (2011). Kreiranje primarnog novca u uvjetima nestabilnosti. In Jakovþeviü, D., Lovrinoviü, I., & Radoševiü, D. (eds). Novac i ekonomski rast: Monetarna politika ekonomskog rasta i zaposlenosti (pp. 49-81). Zagreb : Ekonomski fakultet Zagreb.

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List of Contributors

Marko Primorac, PhD, Faculty of Economics and Business, Zagreb, Croatia Primorac, M. (2014). The Restructuring of Fiscal Equalization System in Croatia. Journal of Economics and Business, 32(2), 213-232. Primorac, M. & Bajo, A. (2014). Fiscal Decentralization and Fiscal Imbalance in European Union Countries. Comparative Public Administration, 14(2), 427-464. Primorac, M. & Bajo, A. (2013). Fiscal Equalization in European Union Countries.The Proceedings of Zagreb Faculty of Economics and Business, 11(2), 75-97. Tea Lovrinoviü, MA, Johannes Gutenberg Universität, Germany Lovrinoviü, I., Primorac, M. & Lovrinoviü, T. (2014). Two Transitions in Croatia. Paper presented at ICESOS 2014, Sarajevo. Can Ergüder, Assoc. Prof., Ministry of Interior, Turkey Ergüder, C. & Kocagül, D. A. (2004). Avrupa Birli÷i Bölgesel Politikalar ve Yapsal Fonlar: Uyum Sürecinde Türkiye øçin Bir De÷erlendirme (European Union Regional Policy and Structural Funds: An Evaluation for Turkey in the Accession Process). Ankara: Asil Publication Distribution. Ergüder, C. (2008). Development of Regional Policy in European Union and Structural Funds. Anakara: Tepav. Ergüder, C. (2011). A Role of Regional Development Agencies on Regional Development: Example of øZKA. Ankara: Altin Nokta Basim Yayin Da÷itim. Teoman Duman, Assoc. Prof., International Burch University, Bosnia and Herzegovina Hamad, M. & Duman T. (2013). An Evaluation of Micro-Credit Programs in Bosnia and Herzegovina Using Porter’s Diamond Model. Eurasian Journal of Business and Economics, 6(12), 27-42. Begiü, N. & Duman. T. (2013). Strategic Marketing Management of Ski Resorts in Bosnia and Herzegovina: A competitive Analysis. International Journal of Academic Research in Business and Social Sciences. 3(8), 496-505. Duman, T. (2012). The Value of Islamic Tourism: Perspectives from the Turkish Experience”, Islam and Civilisational Renewal, 3(4), 719-740.

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Aida Soko, PhD Candidate, Deloitte LLP, Private Sector Lead, Bosnia and Herzegovina Soko, A. (2011). Methodologies of Strategic Cost Reduction in Public Sector and Possibilities of Transferring Private Sector Experiences. Paper presented at the Infodom Conference, Sarajevo and Mostar. Soko, A. (2009). Strategic Cost Reduction – Design and Implementation of Cost Reduction Programs and Creation of Sustainable Operational Platforms. Paper presented at Regional Conference on Business Processes and Knowledge Management, Sarajevo. Soko, A. (2009). Major Obstacles to Microfinance Development in BH and the Region. Presented at International Microfinance Conference, Sarajevo. Alba Cani, BA, Deloitte, Albania Cani, A. (2014). The Impact of Global Financial Crisis in the Albanian Banking System. Journal of Social and Business Studies 1(1), 11-28. Alban Asllani, PhD Candidate, AAB College, Kosovo Asllani, A., Misini, S. & Bytyqi, K. (2014). Peoples Motives In Utilizing The Freedom Of Movement Within The EU: The Case Of Kosovo And Visa Liberalization Within The EU. Paper presented at International Conference on Economic and Social Studies (ICESoS’14), Sarajevo. Asllani, A. (2013). Estimating Money Demand Function using Cointegration Analysis: The case of Canada (1960-2005). European Scientific Journal, 9(16), 304-315. Zeqiri, N., Bytyqi, F. & Asllani, A. (2013). Sources Of Change Within the Telecom Industry in Kosova. European Journal of Scientific Research, 107(4), 589-598. Shkumbin Misini, PhD Candidate, Public Univeristy “ Kadri Zeka”, Kosovo Asllani, A., Misini, S., & Bytyqi, K. (2013). Socio-economic Impact of the EU Visa Liberalization for Kosovo and Peoples Motives in Utilising the Freedom of Movement within the EU. European Perspectives – Journal on European Perspectives of the Western Balkans, 5(2(9)), 15 – 42. Fejza, E., Ismajli, A. & Misini, S. (2013). Competitive Analyses of Local Bakeries in Prishtina. European Scientific Journal, 1, 50-55. Misini, S. & Asllani, A. (2013). Negative Impcats of World Financial Crises in Kosovo. Paper presented at 8th Pan European Conference on international relations, 18-27 September 2013, Warsaw.

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Kujtim Bytyqi, PhD Candidate, University College “Universum”, Prishtina, Kosovo Asllani, A., Misini, S., & Bytyqi, K. (2013). Socio-economic Impact of the EU Visa Liberalization for Kosovo and Peoples Motives in Utilising the Freedom of Movement within the EU. European Perspectives – Journal on European Perspectives of the Western Balkans, 5(2(9)), 15 – 42. Bytyqi, K., Peshkopia, R. & Voss, S. (2011). One Ethnic Group or Three: Ethnic Boundaries, Prejudices and Cultural Capital in the Independent Montenegro. Paper Presented At Regional Research Promotion Program And University Of Fribourg. Bytyqi, K., Peshkopia, R. & Voss, S. (2011). Intergroup Contact Theory and Albanians’ Feeling Temperature toward Greeks: Ethnicity, Fear, Class, and Exposure. Paper Presented At Regional Research Promotion Program And University Of Fribourg. Besjana Laçi, MA, Intesa San Paolo Bank, Albania Ozdemir, A. I., Muzhaqi, A. & Laçi, B. (2013). Trans-Adriatic Pipeline Project and its Potential Effects on Albania. Paper presented at IBAC Conference, Tirane, Albania. Laçi, B. & Hysa, E. (2014). What Are the Measures for the Best Fiscal Policy in Albania. Presented at ICESOS 2014, Sarajevo. Laçi, B. & Ryskulov, U. (2014). The Role of Macroeconomic Variables on the Yield Curve Model: Case of Albania? Presented at ICESOS 2014, Sarajevo. Eglantina Hysa, PhD, Epoka University, Albania Hysa, E. & Hodo, M. (2014). A Historical Perspective of Economic and Financial Stability in South East Europe. Mediterranean Journal of Social Sciences, 5(2), 706-713. Hysa, E. (2014). Defining a 21st Century Education: Case Study of Development and Growth Course. Journal of Educational and Social Research, 3(7), 704-709. Hysa, E. (2013). Adaptation of OLG Model in the Pension System. Pensee Journal, 75(12). Eldin Dobardžiü, MA, International University of Goražde, Bosnia and Herzegovina Gradojeviü, N. & Dobardžiü, E. (2013): Causality between Regional Stock Markets: A Frequency Domain Approach. Panoeconomicus, 60(5), 633-647.

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Dobardžiü, E., Rešoviü, S., & Kijevþanin, V. (2013). Interactions between Stock Market and Foreign Exchange Market: The Case of Serbia. Actual Problems of Economics 4(142), 326-334. Dobardžiü, E. (2013). Dynamic Interactions among International Equity Markets: Serbian Perspective. Economic Themes, 51(1), 123-137. Jasmina Okiþiü, Assist. Prof., University of Tuzla, Bosnia and Herzegovina Okiþiü, J., Remetic-Horvath, S. & Büyükdemir, B. (2014) Stock Selection Based on Discriminant Analysis: Case of Capital Market of Bosnia and Herzegovina. Journal of Economic and Social Studies, 4(2), 5-30. Džafiü, Z., Zahiroviü, S., Okiþiü, J. & Kožariü, A. (2011). Internal and External Obstacles to the Development of SMEs in Bosnia and Herzegovina. Croatian Economic Survey, 13(1), 143-171. Zahiroviü S., Rovþanin A. & Okiþiü, J. (2009). Beta Coefficient Analysis on the Capital Market of Bosnia and Herzegovina. Economic Research, 22(4), 30-40. Kemal Kantarc, Prof. Dr., Akdeniz University, Turkey Kantarci, K., Uysal, M & Magnini, V. (eds.). (2014). Tourism in Central Asia: Cultural Potential and Challenges. USA: Apple Academic Press Kantarci, K. & Develioglu, K. (2013). The Impact of Travel & Tourism Competitiveness Factors on Tourism Performance: The Case of Silk Road Countries. Presented at International Conference on Economic and Social Studies, 2013, Sarajevo. Mustafa Ünver, Assist. Prof., Gumushane University, Turkey Unver, M. (2014). An Application to Analyse The Impacts of Sectoral Growth on Foreign Bank Entries in Transition Economies (19902010). Uluslararas Alanya øúletme Fakültesi Dergisi (Turkish), 6(1). Erdogan, M. & Unver, M. (2015). “Determinants of Foreign Direct Investments: Dynamic Panel Data Evidence”, International Journal of Economics and Finance. Kazim Develio÷lu, Prof. Dr., Akdeniz University, Turkey Develioglu, K. & Kantarci, K. (2014). Clustering Silk Road Countries Based on Competitiveness Factors in Tourism Industry. In Kantarci, K., Uysal, M & Magnini, V. (eds.). Tourism in Central Asia: Cultural Potential and Challenges. USA: Apple Academic Press Kantarci, K. & Develioglu, K. (2013). The Impact of Travel & Tourism Competitiveness Factors on Tourism Performance: The Case of Silk

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Road Countries. Presented at International Conference on Economic and Social Studies, 2013, Sarajevo . Mine Biniú, PhD, Balkesir University, Turkey Biniú, M. (2013). Vergi Uyuúmazlklarnda Alternatif Çözüm Yollar ve Türkiye’de Uygulanabilirli÷i, Hukuk ve øktisat Araútrmalar Dergisi, 5(2), 15- 30. Esener, Ç. & Biniú, M. (2012). Eski Sorunlar øçin Yeni Çözümler: Yeni Bir øúlem Vergisi Önerisi”, Business and Economics Research Journal, 3(4), 123-142 Arslan, M. & Biniú, M. (2012), “Uluslararas Vergi Kayp ve Kaçaklar, Sonuçlar ve Geliúmekte Olan Ülkeler Bakmndan Vergi Rekabeti”, Finans Politik & Ekonomik Yorumlar, 49, 564. Elif Ayúe ùahin øpek, Assist. Prof., Izmir Katip Çelebi University, Turkey Ipek, E. A. ù. & Acar, I. A. (2014). Kamu ønovatif Satn Alma Politikas ve Bölgesel Kalknma. In Bozdo÷an, M. N. Türkiye’de Bölgesel Kalknma ve Teúvik Politikalar. Nobel Yaynclk, 1. Basm. Ipek, E. A. ù. (2014). Türkiye’de Mahalli ødare Bütçeleri ve Sorunlar. In Sakal, M., Kesik, A. & Akdemir, T. (pp. 332-354). Mali Yerinden Yönetim: Teori, Kavramsal Açklamalar ve Türkiye’ye øliúkin De÷erlendirmeler, Nobel Yaynclk, 1. Basm. Çiçek, H. G., Ipek, , E. A. ù. & Dikmen, S. (2014). Terörün Kamu Finansmanndaki Etkisinin Vergi Cennetleri Kapsamnda De÷erlendirilmesi. In Prof. Dr. ùükrü Kzlot’a Arma÷an (pp. 404425). Gazi Üniversitesi øøBF Yayn. Wioletta Nowak, Assist. Prof., University of Wroclaw, Poland. Nowak W. (2014). The Evolution of Development Assistance. Journal of US-China Public Administration, 11(5), 454-462. Nowak W. (2014). Development Effectiveness of Foreign Assistance. NierównoĞci Spoáeczne a Wzrost Gospodarczy, 38(2), 74-84. Nowak W. (2013). The World Bank Revised Minimum Standard Model: Concepts and limitations. Ekonomia - Wroclaw Economic Review, 19(2), 37-48. Zehra Mahmutoviü, MA of Science in Management, International Burch University, Bosnia and Herzegovina Mahmutoviü, Z. (2014). Fiscal stimulus in times of high indebtedness: Policy simulations for the Developing Bosnia and Herzegovina (Unpublished master's thesis). International Burch University, Sarajevo.

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Mahmutoviü, Z. (2014). The Microfinance tale: Bright and dark side of the narrative. Paper presented at ICESoS 2014, Sarajevo. Mahmutoviü, Z. (2014). The abandonment of the poverty-debt cycle by dint of fiscal policy: The modest BH experience. Paper presented at ICESOS 2014, Sarajevo. Ali Coúkun, Prof. Dr., Fatih University, Turkey Ozturk, K. E.; Acar G. & Coskun A. (2014), “Detecting Earnings Management Practices in Banks: Evidence from Turkey”, European Journal of Economic and Political Studies, 7(2): 21-36. Coskun, A. & Yilmaz M. (2013) “Pricing Decisions in Educational Institutions: An Activity based Approach” Procedia – Social and Behavioral Sciences (106) 2112-2118. Coskun, A. & Bayyurt N.(2008), “Measurement Frequency of Performance Indicators and Satisfaction on Corporate Performance: A Survey on Manufacturing Companies?” European Journal of Economics, Finance and Administrative Sciences (13), 79-87. U÷ur Ergün, Assoc. Prof. Dr., International Burch University, Bosnia and Herzegovina Ergün, U. (2012). How does Turkish stock market respond to the external shocks? Pre and post crises analyses. African Journal of Business Management, 6(8), 2878-2881. Ergün, U. & Ozturk, E. (2013). Perceptions of Small and Medium Enterprises on IFRS Adaptation Process: a Case Study in Federation of Bosnia and Herzegovina. Journal of Business Administration Research, 2 (1), 43-48. Ergün, U. & Ibrahim, A. (2013). Global Energy Prices and the Behavior of Energy Stock Price Movements. Asian Economic and Financial Review, 3(11), 1460-1465.