From Recovery to Reinvigorated Growth in South East Europe

Since the onset of the global financial crisis in 2008, the six countries comprising South East Europe (SEE6) - Albania, Bosnia and Herzegovina, Kosovo, FYR Macedonia, Montenegro, and Serbia - have struggled to remain on a path of sustained positive economic growth. The ensuing recession of 2009 was followed by a further contraction in these economies in 2012, as activity in the Eurozone fell sharply. Catastrophic floods devastated the region in May 2014 - further stifling production, investments, and exports in SEE6.

Despite these economic setbacks, the six economies in the region are now experiencing a modest recovery. According to the latest SEE6 Regular Economic Report (RER), growth in the region is set to pick up from 0.3% in 2014 to 1.8% in 2015 and then to an average of 2.6% in 2016-2017, respectively.

Serbia, which was hit hardest by the floods, was the single economy in the region to register negative growth in 2014, with growth for 2015 projected to recover to 0.5%. The region’s faster growing economies – Albania, Kosovo, FYR Macedonia and Montenegro – are expected to see growth of roughly 3% or higher in 2015-2016.

As the region emerges from economic stagnation, the risks to the outlook remain high. Looking at the international economic picture, key factors are the future path for oil prices and the recovery in external markets, particularly in the European Union (EU). In addition, global financial markets remain turbulent, with investors now focusing in particular on the timing of increases in U.S. interest rates and the outlook for China’s economy.

“The region is recovering,” notes Gallina A. Vincelette, World Bank Program Leader and one of the authors of the report, “and now we can double down on this opportunity – introducing reforms that can both help sustain growth in the near term amid heightened risks and at the same time mitigate the risk of a stagnation in the region’s catch-up with high income economies over the medium and long terms.”

From 2000 to 2007, solid growth in the region moved average income per capita (on a PPP basis) up from 23% of the EU average to 31%. However, the speed of these countries approaching average income levels of the EU has leveled off. While cyclical factors, including the weather, have clearly played an important role, there is a broader concern that real income levels in the region may stagnate and the transition to high income status appears far from inevitable for these six countries.

Given the high levels of debt in the region, prudent macro-fiscal policies that include building up policy buffers that can be used to mitigate future shocks are required to ensure that the nascent growth in the region is resilient in the near term. Macro-fiscal stability is also a necessary condition for improved growth performance over the medium-term.

“However, macro-fiscal stability is not enough on its own to deliver renewed income convergence; the implementation of reforms to address long-standing structural challenges is also required,” notes World Bank Senior Economist Ashley Taylor, a co-author of the report. This reform agenda is often multi-faceted and complex. For example, at 20% on average - and up to 45% for youth for the region as a whole - unemployment remains a key structural challenge which both limits the contribution of the workforce to income generation and imposes significant social costs. Eliminating disincentives and barriers to formal employment, as well as more broadly improving governance and the business environment, can help spur investment and job creation in the region.

Reforms to support labor market participation can also unlock the economic contribution of some of the more vulnerable groups in the region – including youth, females, and the elderly - an important issue discussed in the latest SEE6 RER.

Continuation, and strengthening, of ongoing public sector reforms will also be needed to provide the enabling environment for private sector-led growth. This includes reforms of state-owned enterprises to free up space for private enterprises and to enhance the efficiency and quality of infrastructure service provision of core public utilities.

Finally, better quality of public spending in education, skills development, as well as health, will be needed to generate improvements in human capital, reducing skills mismatches and supporting innovation.

These are just some of the examples of the structural reforms that can help to unlock future growth opportunities in the region.

In sum, the experience of the region since the global financial crisis provides a powerful reminder of the risks to the economic transition toward higher income status. The time is now to build on the ongoing economic recovery and to take action to strengthen and sustain growth over the medium term.