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Source: UN Economic Commission for Europe
Date: 05 May 1999
Accessed 06 Ma6 1999
Recovery in Southeast Europe after settlement of the conflict in Yugoslavia
Elements for a contribution by the United Nations Economic Commission for Europe (UN/ECE)
In view of the gravity of the conflict in Yugoslavia, immediate action to prevent dramatic deterioration in the most affected countries has to be taken and preparations for the post-conflict situation for the region have to be launched now.
In the economic field, immediate action relates to compensating countries for the cost of refugees, the loss of exports and the consequences of not being able to use the Danube for transportation purposes (see Annex I).
International institutions and organizations have already embarked on the process of preparing post-conflict stabilization and reconstruction programmes. The ECE mandate, as well as its expertise and experience, make the Commission prepared to participate actively in this most challenging and important process of building foundations for the future inclusion of the entire region into the European order.
The response to the situation at the end of the conflict in Yugoslavia has to be both comprehensive and coordinated to address the complexity of the problem and to avoid divergences in the approach of the international community. It has to address the problems of countries directly and indirectly affected by the military actions, and to contribute to the regional development, openness and integration.
In the economic and social fields, there are at least three broad goals:
THE CRISIS IN SOUTH-EASTERN EUROPE: PRE-CONFLICT DEVELOPMENTS AND POST-CONFLICT RECONSTRUCTION
The conflict in Yugoslavia is not only dominating international politics and relations at the moment, but it has - and will have for some time to come - very serious and wide-ranging economic implications, especially for the countries in and around the war zone. One broader effect of the crisis has been to focus for the first time wide public attention on the economic situation in the whole south-eastern part of Europe, a region that has long been neglected in the mainstream discussions on international economic policy. When considering the effects of the war on south-eastern Europe, it is essential to stress that they are falling on countries where the process of economic and political transformation during the past decade has proved to be much harder than in central Europe and, as a result, have fallen further behind the rest of Europe rather than starting a process of "catching up".
Among the immediate costs of the conflict is the tragic outflow of refugees from Kosovo; the burden of caring for them is considerable and is already causing considerable strains on the economies of The former Yugoslav Republic of Macedonia and Albania. There is clearly an urgent need for very rapid action to support the costs of caring for the refugees, and to compensate for the loss of access to the Yugoslav and European markets. This is essential to preserve political stability in the receiving countries. But there is also an urgent need to consider how to approach the issues of reconstruction, rehabilitation and economic development when the conflict has come to an end and a settlement has been reached. The longer that takes, of course, the greater will be the human and financial costs of the refugee problem. It is vital, however, to start thinking of how to approach the problems of the post-conflict period, despite uncertainty as to when it will start.
The heavy burden of the past
The deep economic problems that the transition economies in south-eastern Europe have been facing since the start of economic and political transformation are complex and interrelated. The increasing number of transformation failures, in particular in south-eastern Europe, provides convincing evidence of the prime importance of a number of factors for the overall success of the transformation process which - although not entirely neglected - were generally given inadequate attention in much of the academic and policy debate in the early phases of transition. Among these factors B which have seriously impaired the process of economic transformation in south-eastern Europe B are the obvious locational disadvantages of the region (in terms of their distance from the most important west European markets), the highly unfavourable starting conditions (in terms of inherited economic distortions), and the lack of historic traditions in institutional development (which has contributed to a persistent institutional hiatus in these countries).
The regional economy had already been destabilized before the conflict by the breakup of the former SFR of Yugoslavia, and the ensuing conflicts in Croatia and Bosnia and Herzegovina, and more recently by the escalation of the Kosovo conflict. The negative side effects of UN sanctions on Yugoslavia were particularly detrimental for some of the countries in the region (Albania, Bulgaria, Romania, The former Yugoslav Republic of Macedonia, for example) and in effect amounted to a strong external shock that added to an already severe transformational recession. Military conflicts, political unrest and general instability in the region have been a strong deterrent to FDI in the region; the countries of south-eastern Europe never became an attractive destination for FDI, unlike the not-so-distant central European transition economies. Regional trading links, never very strong, have been broken during a decade of military conflicts and economic sanctions, and there are now many barriers to their restoration, a fact or which adds to the discentives for significant FDI in the region.
The overall deficiency of resources (in terms of the available physical and human capital, domestic savings and investment) appears to have been the main impediment for recovery and economic stabilization in south-east Europe. Historically, being located in the periphery of the continent, the south-east European region has remained largely underdeveloped. The process of industrialization that took place during over four decades of communist rule was not soundly based; investment decisions in that period did not reflect comparative advantage and expected market returns but rather the arbitrary preferences of central planners. Once these countries were exposed to open competitive pressures from world markets, a large share of the existing capital stock was rendered non-viable as it had little or no value under market conditions.
The actual experience of reforms and economic transformation in the south-eastern part of Europe has been highly problematic. Over the past decade none of the transition economies in this region has been able to embark on a path of sustained economic growth. Many of them still face problems of macroeconomic stabilization; financial and currency crises have been much too common in the region in recent years. These persistent failures have raised considerable doubts about the wisdom of the actual transformation paradigm that has been pursued in these countries during the last decade. The policy approach heavily influenced by the "Washington Consensus" presumed that sustainable macroeconomic stabilization could be easily and rapidly achieved through rapid liberalization and monetary austerity; it was supposed (at least implicitly) that this would then pave the way for setting the economy on a path of high and self-sustained growth, supported strongly by inflows of private capital from abroad. This paradigm embodied strong reliance on the automatic operation of the market mechanism in restructuring the economy, an assumption incorporated B at least implicitly B in the design of the transition programmes.
This transformation paradigm, however, has not proved to be very successful in the transition economies of south-eastern Europe. The reasons are much too complex to be spelled out in a short note, but basically they are related to the factors outlined above: the locational disadvantage of the region, their highly unfavourable starting conditions, and the lack of strong traditions in institutional development. In some cases, the fast liberalization and opening of the economies turned out to be premature and detrimental as these economies were totally unprepared to cope with the external shocks. The scale and speed of the external shocks greatly exceeded the possible rate at which internal economic restructuring and re-allocation of capital and labour could be achieved in these economies, and this resulted in an unwelcome rate of destruction of productive assets and much higher levels of unemployment than were necessary. Over the years, the UN/ECE secretariat has been advocating the adoption of alternative approaches and strategies of reform, especially as regards the region of south-eastern Europe, with much greater emphasis on the building and the development of institutions and market infrastructures, and it has persistently advocated a much higher level of external support for these economies.
The shock waves of the conflict in Yugoslavia on neighbouring countries
The outbreak of the conflict in Yugoslavia has added a new dimension to the already unfavourable external environment for many transition economies, worsening further their short-term economic outlook. The conflict-related economic damage already incurred is quite substantial. Neighbouring countries (Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Hungary, Romania, The former Yugoslav Republic of Macedonia) have lost important markets as well as traditional suppliers in Yugoslavia. The transport links to and from the south-eastern part of Europe have been severely impaired: navigation along the Danube has been paralyzed by the destroyed bridges and all traffic through Yugoslavia (ground, rail and air) has been brought to a halt. The negative effects are especially strong for international trade between western Europe, the main trading partner, and the countries locked in the Balkan region (in particular Bulgaria, Romania and The former Yugoslav Republic of Macedonia): as the available alternative routes are of limited capacity, this has resulted in the direct destruction of important trade flows. In addition, the loss of the Danube as a waterway will have a pan-European negative impact as it is causing costly interruptions in shipments for all the riparian countries. The conflict has undoubtedly increased investors' perception of risk in the whole area surrounding the zone of the conflict and this will restrain access to international financial markets and raise borrowing costs for the affected countries, which in general are badly in need of fresh finance. The inflow of FDI to this region B an important force for economic restructuring as well as balance of payments support B is also likely to be curbed. The fact is that the conflict will have a significant negative economic impact on all the countries in south-east Europe, most of which were already in a precarious economic state.
Quantitative estimates of the "costs" or of the "incurred damage" for any individual affected country must necessarily be largely guesswork due to the lack of precise information as well as unresolved methodological difficulties. However, it is useful to mention some of the transmission channels through which the conflict affects the neighbouring countries. The principal ones are: the cost of supporting refugees in the host countries, direct loss of exports and imports as a result of the disruption of transport routes; increased costs/prices of exports and imports (and, indirectly, further losses due to the deterioration in competitiveness) as a result of re-routing through alternative and more costly transport routes; lower fiscal revenue due to foregone export revenue and lower imports (hence lower duty and other customs receipts); reduced income from tourism (both foreign exchange earnings and fiscal revenue); smaller inflow of FDI due to perceptions of increased risk by foreign investors; and higher borrowing costs on international financial markets. The combined effect of all these negative factors has already had a serious macroeconomic impact comprising a severe balance of payments shock, a loss of aggregate output, increased unemployment, and a deterioration in the fiscal balance and without assistance this will be more severe the longer the conflict lasts.
The countries which have received most of the refugees, The former Yugoslav Republic of Macedonia and Albania, two of the poorest countries in Europe, are bearing a considerable cost in supporting them, perhaps of the order of $0.5-$1.5 million a day. In addition their trade with Europe, most of the total, is disrupted. Their need for speedy assistance is considerable.
Although the precise measurement of the conflict-related economic damage is necessarily uncertain at this stage, it is still useful to quote some of the estimates prepared by official government agencies in some of the other affected countries. Bulgaria estimates its direct export losses due to the conflict at $1.0-1.5 million a day; thus two months of conflict would result in the loss of some 2.5 per cent of its annual exports and if the conflict continues until the end of the year the loss would be some 7 per cent of total exports. In addition Bulgaria expects that it will attract no more than one half of the $1 billion of FDI that was expected in 1998, which will create additional serious problems for financing the country's balance of payments. Romania estimates that it might lose some 15 per cent of its exports to Hungary, Austria and Germany (that is, more than 3 per cent of its total exports) as a result of the conflict. According to high level Romanian government officials, the first month alone of the Kosovo conflict has resulted in total economic damage to Romania amounting to $730 million. Ukraine claims that its direct daily losses due to the conflict amount to $300 thousand. The losses of the Slovenian tourism industry might be as high as 30 per cent of the total tourism-related revenue (that is, more than $300 million), tourism in Croatia, and, indeed, throughout the region is likely to be badly affected this summer.
The spillover costs of the conflict are equivalent to another external shock for the affected countries which will be the stronger, the nearer they are to the conflict zone and the longer the conflict lasts. As all the south-east European transition economies were already in a very precarious state before the conflict, due to their grave domestic problems, they are extremely vulnerable to any additional external disturbances. There is therefore a considerable risk that unless timely and comprehensive measures (supported by adequate resources) are taken by the international community to offset the negative impact of the Kosovo conflict, some of these economies will soon be facing a new round of severe economic crises.
Recovery in south-east Europe
(i) The place of Yugoslavia
The rapid growth of economic damage and the grave economic implications of the Kosovo conflict for the whole of south-eastern Europe demand an urgent response by the international community. It is becoming increasingly evident (and this opinion seems to be shared by a growing number of experts) that a new approach, different from those applied in the past, is needed to address these problems. And it is important to emphasize that we are not speaking of simply providing assistance or rebuilding the assets and infrastructure destroyed in the course of the conflict or of trying to re-start economic transformation using the old paradigms. A key element of such a new approach must be to find ways and means to revitalize and rehabilitate a large European region, encompassing several sovereign states; it must include a comprehensive programme of economic measures that would allow these countries to embark on a path of macroeconomic stability and sustained economic growth and to ensure its eventual re-integration into the wider European economy.
Yugoslavia occupies a special position in the context of the south-eastern region of Europe. Being one of the relatively large economies and strategically located on the main routes to western Europe, it was both an important market for neighbouring countries and an important transit country. As such it will be central to plans for reviving economies in the region when the conflict is over and a settlement reached.
Until the conflict is brought to an end we shall not be able to assess with any accuracy its consequences for the economy of Yugoslavia, but it seems quite safe to say that it will be in a disastrous state. The final extent of the damage will depend on the length of the conflict and the prospects for repairing it will depend on how long it will take for a peace settlement to be reached. The task of rebuilding the economic infrastructure will be considerable and will run into tens of billions of dollars. And it will also require considerable amounts of official assistance to get the process started - until a settlement is reached over Kosovo and security restored to the region as a whole there is unlikely to be any significant inflow of private capital from abroad.
It is important to stress that the Yugoslav economy has been in a parlous state for a long time. Following the second oil shock in 1979 the economy was virtually stagnant for most of the 1980s; it then suffered from the break-up of the former SFR of Yugoslavia, leading to the loss of markets, economies of scale, etc., and then from four years of conflict and international sanctions. After the Dayton Accord of November 1995, little progress was made in restructuring the economy and pushing forward the process of transition to a market economy. The process of economic and political transformation (as was under way, at varying rates, in most of the other transition economies) never got started in Yugoslavia. The persistence of military conflict and external economic sanctions were used by the authorities as a pretext to maintain a strong administrative grip over the economy which became even stronger during periods of open conflict. Over the past decade, this has perpetuated a very specific economic regime in Yugoslavia, predominantly based on the unreformed, "self-governed" firms (which, however, remained closely controlled by the authorities through political nomination of the management) and unreformed state institutions which functioned in a manner that was somewhat similar to a conflict economy. Thus, despite mimicking some reforms (such as partial privatization), Yugoslavia has basically remained a non-starter in economic and political transformation.
The Yugoslav economy will therefore be facing several sets of complex problems when a settlement is finally reached. First, will be the reconstruction of the physical capital stock and infrastructure. This will be a major task and will have to be sequenced over an appropriate time period, starting with emergency measures to restore basic services and then perhaps giving priority to the repair of the transport system, including clearance of the obstacles to traffic on the Danube. Secondly, economic activity has to be switched from conflict time to peacetime objectives; and thirdly, in parallel, the transition process will have to get under way, almost certainly with the transformation of the old self-management system into a private-property based market economy if foreign capital is to be attracted into the country. Fourthly, progress with reconstruction and reform will also depend on a reasonable degree of macroeconomic stability being maintained and, especially, on avoiding the risk of a severe inflation arising from the bottlenecks that will be inevitable in the short run. It is difficult to see how these problems can be tackled effectively, and within a reasonable time so as to preserve social stability, without a major programme of assistance from abroad, namely, from the European Union and other members of the NATO alliance.
(ii) A programme for all the neighbouring countries
It is at this point where suggestions of a Marshall Plan are usually made. Unfortunately, such suggestions are often made as though the Marshall Plan was simply a synonym for providing large amounts of financial assistance to solve large problems, preferably on the generous terms provided to Western Europe by the United States in 1948. Financial assistance is important - and the reconstruction of Yugoslavia and the rehabilitation of south east Europe in general will require large amounts of it; but the ECE secretariat has long emphasized a number of features of the Marshall Plan which make a similar approach appropriate for the transition economies, and especially those of south east Europe:
In this framework it is important to stress that Yugoslavia will be of central importance for any improvement in the regional economy. The size of its economy alone and the fact that most of the principal transport routes of the region pass through Yugoslavia mean that most of the region's problems are unlikely to be solved without its cooperation.
The South East European Cooperation Initiative (SECI) is a step forward in the process of building a framework for regional cooperation. It has already shown tangible results in harmonizing and simplifying procedures related to border crossing and demonstrated the capacity and the will of the participating states to address collectively problems of common interest. Launched by the United States, it has now received the support of the EU and the Russian Federation, which makes it a potentially useful tool for developing a much bigger programme for the post-conflict task of political and economic reconstruction and development in the region: this will require, as suggested above, large amounts of financial assistance, but also a major and long-term political commitment by the major donors to the region over many years.
One conclusion that should also be drawn, however, both from the experience of the Marshall Plan and from the transition process in south east Europe since 1989, is that there are no easy answers and no short cuts. The experience of Bosnia and Herzegovina since the Dayton agreement is also a reminder that although the military parts of a settlement can be agreed fairly quickly, economic reconstruction, even when funds are provided, can be an extremely slow process if the various parties are unwilling to cooperate. Nevertheless, in other circumstances, generous assistance can improve the chances of greater cooperation simply by increasing the opportunity cost of non-cooperation.
A final lesson I would draw here from the Marshall Plan is for the potential donor countries of western Europe: essentially it represented an intelligent and far-sighted appraisal of what was required to ensure long-term economic and political stability in western Europe - and, as it turned out, the intelligent pursuit of self-interest proved to be compatible with generosity towards the less fortunate and more vulnerable. West European leaders will need to demonstrate a similar degree of farsightedness and commitment when eventually the bombs stop falling and the guns fall silent in Yugoslavia. If they do not, economic backwardness and stagnation in south eastern Europe will simply preserve an environment in which threats to the security of Europe as a whole will continue to arise.
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