Western Balkans Regular Economic Report WORLD BANK GROUP No. 26 - Fall 2024 Retaining the Growth Momentum Western Balkans Regular Economic Report No.26 | Fall 2024 Retaining the Growth Momentum © 2024 The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org Some rights reserved This work is a product of The World Bank. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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Western Balkans Regular Economic Report No. 26 Fall 2024” © World Bank.” Any queries on rights and licenses, including subsidiary rights, should be addressed to World Bank Publications, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e mail: pubrights@worldbank.org. Acknowledgements This Regular Economic Report (RER) covers economic developments, prospects, and economic policies in the Western Balkans region: Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, and Serbia. The report is produced twice a year by a team led by Isolina Rossi, Richard Record, and Maryna Sidarenka (Task Team Leaders). This issue’s core team included World Bank staff working on the Western Balkan countries (with additional contributions to specific sections): Christos Kostopoulos, Maryna Sidarenka, Nathalie Lahire, Ivan Torre (Growth section), Sanja Madžarević-Šujster, Joana Madjoska, Tim Pionteck, Costanza de Acutis (Labor section), Alexandru Cojocaru, Carlos Gustavo Ospino Hernandez, Anna Fruttero, Zurab Sajaia (Poverty section), Milan Lakićević, Besart Myderrizi (Fiscal section), Isolina Rossi, Tim Pionteck (Monetary section), Jane Hwang, Valeria Salomao Garcia (Financial sector section), Sandra Hlivnjak, Tihomir Stučka (External section), Richard Record, Lazar Šestović, Marie Sabine Albert, Costanza de Acutis (Outlook section), Mauro Testaverde, Daniel Garrote Sanchez and Helly Dharmesh Mehta (Spotlight). The team is thankful for comments received from the peer reviewers Jamele Rigolini, Evgenij Najdov and Indhira Vanessa Santos. Research assistance was provided by Suzana Jukić and Tim Pionteck. Peter Milne, Timothy Justin Kortschak provided assistance in editing, and Vigan Kada assistance in designing. The dissemination of the report and external and media relations are managed by an External Communications team comprised of Filip Kochan, Lundrim Aliu, Anita Božinovska, Ana Gjokutaj, Jasmina Hadžić, Gordana Filipovic, and Mirjana Popović. The team is grateful to Xiaoqing Yu (Regional Director, Western Balkans); Asad Alam (Regional Director, Prosperity); Jasmin Chakeri (Practice Manager, Macroeconomics, Trade, and Investment Global Practice); Paolo Belli (Practice Manager, Social Protection and Jobs); and the Western Balkans Country Management team for their guidance in the preparation of this report. The team is also thankful for comments on earlier drafts of this report received also from Ministries of Finance and Central Banks in Western Balkan countries. This Western Balkans RER and previous issues may be found at: www.worldbank.org/eca/wbrer/. Contents Retaining the Growth Momentum 13 1. Overview  14 2. Growth is accelerating supported by strong domestic demand  19 3. Solid growth is driving employment in 2024  27 4. Closing gender disparities can support stronger poverty reduction in the region  35 5. Maintaining fiscal prudence is needed to preserve past consolidation gains  39 6. Inflation is continuing to decelerate, but at a slower pace  47 7. Financial stability remains resilient amid uncertainty, helping to support credit growth 50 8. The external deficit has been widening amid continued external pressures 55 9. The growth outlook: diverging growth drivers  58 10. Spotlight: Reaping the Benefits of a Global Workforce  68 Country Notes 92 Albania93 Bosnia and Herzegovina 96 Kosovo99 Montenegro  102 North Macedonia 105 Serbia108 Figures FIGURE 2.1. 19 GDP is accelerating amid a complex external environment  19 FIGURE 2.2. 19 Domestic demand is the main driver of economic growth 19 FIGURE 2.3. 21 Trade is expected to be a drag on growth in 2024 in all WB6 countries… 21 FIGURE 2.4. 21 …driven largely by a reduction in services 21 FIGURE 2.5. 23 ECA-HCI - Western Balkans, ECA and EU 23 FIGURE 2.6. 24 Higher education is underperforming in the WB6 and ECA 24 FIGURE 3.1. 27 Continued employment growth in 2024... 27 FIGURE 3.2. 27 ...has led to historically high employment rates 27 FIGURE 3.3. 28 Construction and services created new jobs 28 FIGURE 3.4. 28 More people joined the WB6 labor force 28 FIGURE 3.5. 29 Unemployment rates have declined further in the WB6 in 2024 29 FIGURE 3.6. 30 Unemployment rates still compare poorly with the EU27, especially for the youngest and prime age workforce30 FIGURE 3.7. 31 The highest unemployment rates are found among younger women with only primary educational attainment31 FIGURE 3.8. 31 Regional unemployment rate disparities persist at times of serious labor shortages 31 FIGURE 3.9. 32 Replacement rates are higher than in the EU27 32 FIGURE 3.10. 33 Real wage growth and unemployment in the Western Balkans (2017–2023) 33 FIGURE 3.11. 34 Average real wage and productivity growth, 2015–2023 34 FIGURE 3.12. 34 Labor shortages as business obstacles in the WB6 countries, 2019–2023 34 FIGURE 4.1. 35 Poverty reduction has de-escalated in recent years 35 FIGURE 4.2. 36 Regional and country-specific Prosperity Gap, 2019 and 2023 36 FIGURE 4.3. 36 Contribution of each country to the regional Prosperity Gap, 2023 36 FIGURE 4.4. 38 Gender Employment Gaps Index 38 FIGURE 5.1. 39 Fiscal deficits are widening in 2024… 39 FIGURE 5.2. 39 …against broad based expenditure growth  39 FIGURE 5.3. 41 Capital spending has rebounded… 41 FIGURE 5.4. 41 …while all WB6 countries have turned to higher spending on social benefits 41 FIGURE 5.5. 41 Public and publicly guaranteed debt as a share of GDP has declined to its lowest in a decade… 41 FIGURE 5.6. 41 …as has external public and publicly guaranteed debt 41 FIGURE 5.7. 46 The Country Fiscal Rule Strength Index for the WB6 countries and the EU member states from CESEE 46 FIGURE 5.8. 46 Scope Index for Independent Fiscal Institutions, in the WB6 countries and the EU member states from CESEE46 FIGURE 5.9. 46 Medium-term budgetary framework index, in the WB6 countries and the EU member states from CESEE46 FIGURE 6.1. 47 The pace of decline in core inflation has slowed this year 47 FIGURE 6.2. 47 In the Euro area service inflation remains elevated 47 FIGURE 6.3. 48 Inflation heterogeneity among countries persists 48 FIGURE 6.4. 48 WB6 core inflation remains high 48 FIGURE 6.5. 49 Central banks have cautiously initiated an easing of monetary policy… 49 FIGURE 6.6.  49 …continuing to allow for different degrees of exchange rate flexibility 49 FIGURE 7.1. 50 Credit growth rebounded in H1 2024  50 FIGURE 7.2. 50 Corporate credit growth resumed its pace narrowing the gap with household growth  50 FIGURE 7.3. 51 Asset quality showed limited movement  51 FIGURE 7.4. 51 Capital levels remained relatively stable 51 FIGURE 7.5. 53 Average cost of sending US$200 in remittances to WB6 countries (Q2, 2024) - percent 53 FIGURE 8.1. 56 The regional current account deficit has been widening in 2024… 56 FIGURE 8.2. 56 …with Albania, North Macedonia and Serbia accounting for the bulk of the external adjustment in 2024  56 FIGURE 8.3. 56 The merchandise trade deficit has returned to the five-year average seen prior to the pandemic, after the deterioration in 2022… 56 FIGURE 8.4. 56 …while remittances and net services exports have stagnated  56 FIGURE 8.5. 57 At the regional level, FDI inflows almost fully finance the current account deficit in 2024, although country differences are significant…  57 FIGURE 8.6. 57 …with the regional PPG external debt level projected to remain largely unchanged in 2024 57 FIGURE 9.1. 59 Contribution to growth, spring vs. autumn projections 59 FIGURE 9.2. 60 Economic Sentiment Index 2021–2024 60 FIGURE 9.3. 63 To achieve high-income status, countries will need to recalibrate their mix of investment, infusion and innovation policies 63 FIGURE 9.4. 64 Percent reduction in 2050 GDP from selected climate hazards under RCP 4.5 64 FIGURE 9.5. 66 Incremental public investment under trend growth, percent of GDP 66 FIGURE 9.6. 66 Incremental private investment under trend growth, percent of GDP 66 FIGURE 10.1. 69 Stock of emigrants from Western Balkan countries in 2021 69 FIGURE 10.2. 70 Main destination countries and regions of Western Balkan emigrants 70 FIGURE 10.3. 71 Wage differentials across Europe and net migration 71 FIGURE 10.4. 72 Profile of emigrants from the Western Balkans in OECD countries 72 FIGURE 10.5. 73 Labor market outcomes of Western Balkan emigrants in OECD destination countries 73 FIGURE 10.6. 74 Remittances in WB6 countries as a share of GDP (2023) 74 FIGURE 10.7. 77 Impact of emigration on the supply of labor and skills in Western Balkan countries  77 Tables TABLE 1.1. 17 Western Balkans outlook, 2021–26 17 TABLE 2.1. 23 Prevalence of adult health risk factors and indicators of higher education 23 TABLE 5.1. 43 Yields on WB6 countries outstanding Eurobonds 43 TABLE 5.2. 43 Credit ratings of the WB6 countries 43 TABLE 9.1. 58 Real GDP growth in WB6 countries, percent 58 TABLE 9.2. 65 Undiscounted costs of proposed policy actions and investments for an initial detailed adaptation package (in 2020 US$ billion, US$ undiscounted) 65 TABLE 9.3. 65 Estimated CAPEX of mitigation measures under trend growth by 2050 (US$ billion, US$ discounted at 6 percent) 65 TABLE 10.1. 85 Recommendations85 Boxes Box 2.1: How can the WB6 countries improve their human capital outcomes? Recent evidence from an extension of the Human Capital Index 22 Box 3.1: Who are the unemployed in the Western Balkans? 30 Box 3.2: Does the Phillips Curve hold true in the Western Balkans? 33 Box 4.1: Gender Employment Gaps Index (GEGI)   37 Box 5.1: Fiscal governance in the WB6 countries: Ensuring fiscal sustainability 44 Box 7.1: Migration and digitalization: How payment systems act as a lever 53 Box 9.1: Escaping the middle-income trap: Insights for the Western Balkans from the new World Development Report 61 Box 9.2: Responding to climate change in the Western Balkans 64 Box 10.1: Data source and challenges to estimate migration numbers 69 Box 10.2: The impact of Albanian returnees after the crisis in Greece 75 Box 10.3: The Heimerer College in Kosovo 79 Box 10.4: The Diaspora Invest Project in Bosnia and Herzegovina 82 Box 10.5: Diaspora engagement in Ireland 88 Abbreviations AE Advanced Economies IFRS International Financial rhs right-hand scale BCR Benefit-to-Cost Ratio Reporting Standard RS Republika Srpska BLAs Bilateral Labor ILO International Labour SDG Sustainable Development Agreements Organization Goals BOP Balance of Payments IMF International Monetary SEPA Single Euro Payment Area Fund SILC Survey of Income and BSSA Bilateral Labor and Social K/Y Capital-Output Ratio Living Conditions Security Agreements KNOMAD Global Knowledge SMEs Small and Medium CAD Current Account Deficit Enterprises Partnership on Migration CAPEX Capital Expenditure and Development SOEs State-Owned Enterprises CBAM Carbon Border LCU Local Currency Unit TIPS TARGET Instant Payment Adjustment Mechanism Settlement LFS Labor Force Survey CCDR Country Climate and TP Talent Partnership LIC Low-Income Country Development Report TTL Task Team Leader LP Labor Participation CESEE Central, Eastern, and UHCI Utilization-adjusted Southeastern Europe LTGM Long-Term Growth Model Human Capital Index CEB Council of Europe lhs left-hand scale UN United Nations Development Bank MIC Middle-Income Country UN United Nations CPI Consumer Price Index MIPEX Migrant Integration Policy DESA Department of Economic Index and Social Affairs CR Coverage Ratio UNDP United Nations DI Diaspora Invest MTBF Medium-Term Budgetary Development Programme Framework DPL Development Policy Loan US United States NMS New Member States EC European Commission WB6 Western Balkans Six NPLs Non-Performing Loans ECA Europe and Central Asia WBR Western Balkan NZ Net Zero Regulation EFTA European Free Trade Association OECD Organisation for WDI World Development Economic Co-operation Indicators EIB European Investment and Development WDR World Development Bank PES Public Employment Report EMDEs Emerging Markets and Services WHO World Health Organization Developing Economies PISA Programme for y/y year-on-year E&S Environmental and Social International Student ESI Economic Sentiment Assessment Indicator PMI Purchasing Managers' EU European Union Index FDI Foreign Direct Investment PM2.5 Particulate matter 2.5 micrometers or less in FY Fiscal Year diameter GEGI Gender Employment Gaps PM10 Particulate matter 10 Index micrometers or less in GDP Gross Domestic Product diameter GHG Greenhouse Gas pp Percentage Points GSI Green, Social, and Impact ppb parts per billion GSPs Global Skills Partnerships PPP Purchasing Power Parity H1 First Half PPG Public and Publicly WB6 Country Abbreviations: Guaranteed (Debt) ALB Albania H2 Second Half Q1 First Quarter BiH Bosnia and Herzegovina HBS Household Budget Survey Q2 Second Quarter KOS Kosovo HEWS Heat Early Warning Systems Q3 Third Quarter MKD North Macedonia Q4 Fourth Quarter MNE Montenegro HIC High-Income Country SRB Serbia ICT Information and RCP Representative Communications Concentration Pathway Technology Note: All comparisons are year-on-year RER Regional Economic Report unless otherwise stated. Retaining the Growth Momentum WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 1. Overview The economies of the Western Balkans (WB6) percent in 2024, up from a mere 1.0 percent in continue to navigate a complex operating 2023, driven by stronger consumption growth environment, and despite experiencing a and supported by expansionary wage policies. In moderate acceleration in growth, uncertainty Albania, growth in 2024 is forecast to be close to remains high. This year, the region is expected last year’s performance of 3.3 percent, supported to rely more on domestic than foreign demand. by household consumption, which has benefited Economic growth in 2024 has been supported from higher wages and moderating inflation. In by expansionary fiscal policies, rising credit Montenegro, growth for the year is forecast to availability, and easing of price pressures, which slow to 3.4 percent, down from 6.3 percent in have resulted in increased consumption and 2023, owing to a weaker tourism season. investment on the demand side, together with growth in the construction and services sectors on The region’s labor market saw further the supply side. However, sluggish performance improvement in 2024, with employment across key European trading and investment reaching a historical high of 48.5 percent in partners has limited external demand, and June 2024. Although still lower than the rate of previous rapid growth in demand for services 54.4 percent of the EU27, a 6-percentage point (particularly tourism) has plateaued. As a result, increase since mid-2021 means that the gap is unlike in 2023, neither trade in goods nor narrowing. In Albania and Montenegro, the services is expected to contribute to growth in employment rate (15+) is above the EU27. In 2024. During the year, the slowdown in inflation Kosovo, despite recent gains, only 37.1 percent and increase in wages has also contributed to of the working-age population is employed. growth by supporting higher disposable incomes. Between mid-2023 and mid-2024, an additional Uncertainty related to the strength of demand in 114,000 jobs were created in the region, of which the EU and its impact on the region remains Serbia saw the largest nominal gains (48,400), high, and retaining the growth momentum will followed by Bosnia and Herzegovina (39,000). require a combination of structural reforms and However, a tightening labor market has led to closer economic integration. increased concerns among businesses citing labor shortages and skills mismatches. Economic growth in the Western Balkans as a whole is expected to accelerate to 3.3 percent Poverty reduction in the Western Balkans has in 2024, up from 2.6 percent in 2023. Serbia— continued its downward trend but at a slower the largest economy in the region—is projected to pace than in the pre-pandemic period. On reach 3.8 percent GDP growth in 2024, up from current trends, poverty is estimated to fall by 2.5 percent a year ago, driven by a recovery in roughly 1 percentage point annually. This slower private consumption and investment. In Bosnia reduction is primarily attributed to a combination and Herzegovina (BiH), growth is expected to of slower economic growth and food and price quicken to 2.8 percent from 1.7 percent in 2023, shocks during 2022-2023. Recent wage increases largely due to a recovery in private consumption in the region may not necessarily translate into fueled by an increase in minimum wages and significant increases in the welfare of households a tightening labor market. Growth in Kosovo below the poverty line, as a significant share of is also projected to accelerate to 3.8 percent in these households are characterized by long-term 2024, supported by consumption underpinned unemployment or high levels of inactivity. by rising incomes, credit, and public spending. After three years of consolidation, WB6 In contrast, North Macedonia is struggling to countries are set to experience widening fiscal recover, with growth projected to increase to 1.8 deficits during 2024 as spending pressures 14 Overview RETAINING THE GROWTH MOMENTUM build. Revenue performance remains robust price inflation eased from 4.4 percent at the across the region, but expenditures are increasing outset of the year to 3.2 percent by July. By July at a fast clip. Nominally, tax revenue growth 2024, Serbia and Montenegro recorded the for the first half of the year remained strong highest headline inflation rates, at 4.3 and 3.5 across all six countries, helped by compliance percent, respectively, above the regional average. gains. Spending increases are broad based, but Conversely, North Macedonia (3 percent), spending pressures on social benefits, pensions Kosovo (2.2 percent), Albania (2.0 percent), and wages are particularly acute. Most of the and Bosnia and Herzegovina (1.8 percent) countries are also experiencing a rebound in reported inflation rates below the regional mean. capital spending. The average fiscal deficit level The continued downward inflationary trend for the WB6 economies is expected to increase by is partially attributable to the normalization of 1 percentage points of GDP, reaching 2.5 percent international commodity prices. Recent weather of GDP in 2024. Serbia is the only country in events, however, may lead to renewed pressure the region expected to maintain the same level of on food prices during the remainder of 2024. deficit from the previous year, while Montenegro Energy prices have also decreased, mirroring is expected to experience the highest increase the general trend of headline inflation, albeit after closing 2023 with a fiscal surplus. North exhibiting some volatility during the first half of Macedonia is expected to continue running a 2024. large deficit. Credit growth has picked up in 2024, after After three years of consistent decline, public slowing in 2023. Average credit growth steadily and publicly guaranteed debt in the region is increased in the first half (H1) of 2024, following estimated to increase only slightly in 2024. the deceleration observed in 2023, with growth Public debt for the Western Balkans as a whole reaching 9.4 percent in June 2024 (from 6.5 is expected to experience an increase as a share of percent in December 2023). In particular, credit GDP, from 46.8 percent in 2023 to 47.2 percent growth increased in Albania (13 percent as of June in 2024. Montenegro and North Macedonia are 2024), driven by an overall pick-up in business driving this regional increase, with public debt as activity and an easing of credit conditions, and a share of GDP rising by 2.8 and 1.5 percentage also in Montenegro. Kosovo continued to post points in 2024, respectively. Montenegro’s the highest level of loan growth among the increase is primarily due to the issuance of a Western Balkan economies (13.6 percent as Eurobond to cover 2024 financing needs and of June 2024). Despite an uncertain economic create a buffer for 2025. North Macedonia’s environment, asset quality has remained mostly increase is driven by a persistently high fiscal stable in the financial sector and capital buffers deficit and the greater issuance of domestic remain sufficient, broadly stable non-performing securities for liquidity purposes. Both Serbia loans and an average capital adequacy ratio of and Montenegro saw positive sovereign ratings 19.1 percent. actions during the year. Given that global interest rates remain elevated and economic conditions WB6 countries are navigating increasing continue to be volatile, fiscal prudence is essential pressures on their external sectors amid to prevent unsustainable debt levels, particularly a challenging external environment. The given uncertainty surrounding external widening regional current account deficit borrowing costs. (CAD) is partly driven by sluggish growth in the EU, particularly in Germany, a key trading In line with international trends, in 2024 partner. Therefore, weakened foreign demand for the WB6 countries experienced a reduction exports, coupled with still-elevated energy costs in inflation, though the pace of this decrease and sluggish labor markets in the EU impacting has slowed. At the regional level, consumer remittance inflows, has led to a deterioration in Overview 15 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 the current account. Across most of the region, The structural reform agenda remains critical both merchandise exports and imports are in order to retain the growth momentum in expected to exhibit a downward adjustment this the Western Balkans toward more sustainable year in GDP terms. Similarly in 2024, the sharp improvements in living standards and rise in net services export inflows seen since 2021 closer economic integration. The EU’s New is expected to come to an end. Remittances are Growth Plan for the Western Balkans offers a also expected to stagnate over 2024, in GDP combination of new financing opportunities as terms. Overall, the current account deficit is well as early access to selected aspects of the single expected to deteriorate from 4.1  percent of market. An expansion of the geographic scope of GDP in 2023 to an estimated 5.6  percent in the Single Euro Payments Area (SEPA) to some 2024, although this is still significantly below the of the WB6 countries as early as 2025 would average over the past five years. Three countries help support market integration and remove in particular—Albania, North Macedonia and barriers to financial flows. The opening up of Serbia—are projected to experience a more “green lanes” to allow for faster trade facilitation pronounced current account widening in 2024, could accelerate value chain integration between in the order of 3.0, 2.5 and 1.5  percent of the Western Balkans and the EU. Similarly, GDP, respectively. Nevertheless, at the regional domestic market reforms to boost competition, level, 95  percent of these deficits are financed upscale innovation and attract higher quality through net FDI inflows, and most countries foreign investments could accelerate growth and in the region experienced an increase in foreign job creation. Meanwhile, there are continued exchange reserves in the past year. risks to the outlook, mainly stemming from sluggish global growth, higher financing costs, Growth in the WB6 is expected to increase political uncertainty and an increasing frequency moderately over the projection period, with of extreme weather events. In all six economies, a change in the drivers of growth. Compared labor market and social protection reforms with projections in the Spring edition of the would help increase labor force participation, Western Balkans Regular Economic Report, in particularly for women. And expanding childcare 2024, the expected increase in growth for the services would not only improve labor market region will be higher by 0.1 percentage points. opportunities for women but also enhance This revision is driven primarily by an increase children’s school readiness through better early in projected growth for Serbia (+0.3 pp), Bosnia childhood education. and Herzegovina (+0.2 pp), and Kosovo (+0.1 pp). On the other hand, there was a decrease in The transition to net zero will require expected growth in North Macedonia in 2024 substantial investments in the Western (-0.7 pp compared with the Spring projection). Balkans, predominantly to be made by the Consumption and investment are expected to private sector, with governments playing a play a more significant role in supporting growth complementary role. New analysis as part of during the coming years, as export demand the 2024 Western Balkans Country Climate remains muted with import growth outpacing and Development Report finds that the largest exports growth. Within the region there is investments would need to be channeled into noticeable division between those countries decarbonizing transport and scaling up solar, which are seeing a faster recovery of consumption wind, and hydro generation capacities across and investment (namely Albania, Kosovo, the region. Investments will also need to be Montenegro and Serbia), and those (such as accompanied by regulatory reforms, including Bosnia and Herzegovina and North Macedonia) but not limited to: (i) adoption of carbon prices; where lower external demand and domestic fiscal (ii) harmonization of the power sector’s legal and pressures are acting as a drag on growth. regulatory frameworks for integration into the pan-European electricity market; (iii) investing 16 Overview RETAINING THE GROWTH MOMENTUM in training and reskilling of existing labor; (iv) and as a share of their populations (34 and structural changes in the education system over 32 percent, respectively). WB6 emigrants are the longer term; and (v) increased coverage and concentrated among the prime age population adequacy of social protection and health systems. compared to both natives in host countries and the non-migrant population at origin, consistent The Spotlight in this edition of the Western with employment being a primary driver of Balkans Regular Economic Report focuses emigration. Educational levels among WB6 on migration, a fact of life for many people migrants have traditionally been low. However, from the WB6. Today, close to one in four while only one in six WB6 migrants in 2015 people from the Western Balkans resides abroad, had tertiary education, more recent data suggest making the region one of the largest origin of that WB6 emigrants’ education levels have been migrants relative to its population around the increasing over the past decade. As large number world. Bosnia and Herzegovina, and Albania of Western Balkan citizens leave the region, are the main sending countries, both in terms of foreign workers have increasingly arrived to fill stocks (1.7 million and 1.4 million, respectively) emerging labor shortages. TABLE 1.1. Western Balkans outlook, 2021–26 2021 2022 2023e 2024f 2025f 2026f Real GDP growth (percent) Albania 8.9 4.9 3.4 3.3 3.4 3.4 Bosnia and Herzegovina 7.4 4.2 1.7 2.8 3.2 3.9 Kosovo 10.7 4.3 3.3 3.8 3.9 4 North Macedonia 4.5 2.2 1 1.8 2.5 3 Montenegro 13 6.4 6.3 3.4 3.5 3.2 Serbia 7.7 2.5 2.5 3.8 4.2 4 WB6 7.9 3.4 2.6 3.3 3.7 3.7 Real GDP components growth (percent) Consumption 4.8 3 1 3.2 2.9 3.1 Investment 2.2 1.3 -0.8 2.2 1.6 1.2 Net exports -0.4 -1.6 2.1 -2.1 -0.8 -0.5 Exports 9.9 6.6 1.6 2.4 3.3 3.2 Imports (-) 10.3 8.2 -0.5 4.5 4.1 3.7 Consumer price inflation (percent, period average) 3.2 11.8 9 3.4 2.6 2.3 External sector (percent of GDP) Goods exports 25.2 28.5 25.6 24.9 25 25.2 Trade balance -16.7 -18.7 -14.3 -14.9 -15 -14.8 Current account balance -5.7 -7.7 -4.1 -5.6 -5.9 -5.8 Foreign direct investment 5.9 6.9 5.3 5.3 5.2 5.2 External debt 83.1 75.3 70.7 70.2 69.3 69.3 Public sector (percent of GDP) Public revenues 35.9 34.8 36.4 37.1 36.8 36.9 Public expenditures 38.8 37.5 37.8 39.6 39.2 39.1 Fiscal balance -3 -2.7 -1.5 -2.5 -2.5 -2.3 Public and publicly guaranteed debt 56.5 50.4 46.8 47.2 46.9 46.8 Sources: National statistical offices; Ministries of Finance; central banks; World Bank staff estimates. Note: e = estimate; f = forecast. Overview 17 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Migration shapes lives, livelihoods and Both emigration of WB6 nationals and aspirations of the Western Balkans population immigration of foreigners are expected to via multiple and interrelated channels. By continue in the coming years, drawing the moving abroad, migrants experience significant attention on the importance of well-designed income gains, with benefits for their families and carefully implemented policies. Despite back home, as well. In fact, remittances are a key a progressive convergence of incomes in recent source of income for WB6 recipient households years, differentials in economic opportunities and support poverty reduction among vulnerable and quality of services with Western European groups in the region. Beyond remittances, the countries remain large, fueling intentions to benefits of an internationally mobile population emigrate. As such, a critical question is how to can be significant. The diaspora can channel make migration yield positive impacts for the international savings, transfer know-how and Western Balkans economies while at the same new technologies, and link the economy to time ensuring the safety and prosperity of both global business networks. All of this can spur migrants and their communities left behind. productivity, exports, entrepreneurship and job In recent years, WB6 countries have made creation. However, emigration has reduced the significant efforts to improve the management supply of labor in all Western Balkan countries. of migration flows and strengthen their Between 2000 and 2020, the population fell by 8 developmental impacts. percent, equivalent to 1.2 million people. While these emigration outflows initially alleviated labor Overall, Western Balkan countries are market pressures, they may have also increasingly at an important juncture, with a unique fueled labor shortages across the skills spectrum. opportunity to better leverage the role of migration to enhance economic development. The Spotlight suggests that emigration does With some of the largest diasporas around the not always lead to human capital losses if world as a share of the population, migration the right incentives are in place. Emigration has been part of the region’s identity for decades. can be a source of human capital accumulation Countries have made substantial progress in in the WB6 through different channels. First, developing their migration systems. Despite remittances sent by emigrants increase the these efforts, relevant gaps remain. The Spotlight availability of financial resources in emigrant provides several options for policies that can households, which can spend part of them on the support a more holistic and development- education of family members who do not migrate. centric approach to support the Western Balkan Second, the return of high-skilled migrants may mobile population for the benefit of migrants also represent a “brain gain” opportunity for the and local economies alike. Time is of the essence country. Emigrants themselves often acquire new in addressing the existing challenges. From the educational degrees and skills overseas, which perspective of the emigrant population, the large positively revert to the country when they return. diasporas can still be engaged and supported via Third, the prospects of higher wages abroad in multiple channels to participate in countries’ specific sectors can further incentivize human economic development. From the perspective of capital accumulation in origin countries. In the foreign-born workers, recent trends have shown Philippines, evidence shows that more migration that immigration will continue growing to fill pathways for nurses in the United States led to an important workforce gaps. As such, the WB6 even faster increase in enrolment and graduation countries can take action to further develop their of nurses in the country. Some promising systems to select, train, and integrate foreign initiatives in the Western Balkans show that these workers in their economies and, more broadly, effects may also materialize in the region, when in their societies. suitable programs are implemented. 18 Overview RETAINING THE GROWTH MOMENTUM 2. Growth is accelerating supported by strong domestic demand The WB6 countries continue to navigate a Economic growth is expected to accelerate complex economic landscape, relying more on to 3.3 percent in 2024, up from 2.6 percent domestic demand and less on foreign trade. in 2023. Growth is projected to accelerate, Economic growth in the WB6 region is supported primarily supported by domestic demand by expansionary fiscal policies, rising credit amidst sluggish growth in the EU. By year- availability, and strong income and transfers from end, Serbia—the largest economy in the abroad, which have boosted consumption and region—is projected to reach 3.8 percent GDP investment on the demand side, together with growth, up from 2.5 percent in 2023, driven growth in the construction and services sectors by a recovery in private consumption and on the supply side. Unlike in 2023, neither trade investment (Figures 2.1 and 2.2). In Bosnia and in goods nor services is expected to contribute to Herzegovina, growth is forecasted to rise to 2.8 growth in 2024. For this year, the slowdown in percent from 1.7 percent in 2023, largely due inflation has further supported growth by to a recovery in private consumption fueled increasing disposable incomes. Sluggish growth by rising minimum wages and a tightening in the EU, particularly in Germany—a key labor market. Growth in Kosovo is also trading partner—and weakened foreign demand projected to accelerate to 3.8 percent in 2024, for exports are weighing negatively on growth supported by consumption driven by rising potential through the trade channel and incomes, credit, and public spending. North remittances. The new Reform and Growth Plan Macedonia, is expected to see growth increase for the Western Balkans, adopted by the to 1.8 percent, up from a mere 1 percent in European Commission in November 2023, 2023, driven by stronger consumption growth offers opportunities to advance economic and supported by expansionary wage policies. integration, and more fundamentally to boost In Albania, growth for 2024 is expeted to investment and productivity. It provides be similar to last year’s performance of 3.3 budgetary and investment support in the form of percent, supported by increased household grants and concessional loans aimed at fostering consumption, resulting from higher wages and economic development and facilitating the moderating inflation. In Montenegro, growth integration of the WB6 countries into the EU by slowed after a strongQ1 performance of 4.4 promoting growth and structural transformation. percent, declining to 2.7 percent in Q2 due to FIGURE 2.1. FIGURE 2.2. GDP is accelerating amid a complex Domestic demand is the main driver of external environment economic growth 100 = 2019 GDP for each country Annual growth and percentage point contribution 120 ALB MKD Consumption Investment BIH MNE Net exports Real GDP growth (%) 115 KOS SRB 8.0 110 6.0 4.0 105 2.0 0.0 100 -2.0 95 -4.0 -6.0 90 -8.0 2024e 2024e 2024e 2024e 2024e 2024e 2023 2023 2023 2023 2023 2023 85 80 2019 2020 2021 2022 2023 2024e ALB BIH KOS MKD MNE SRB Source: National statistical offices and World Bank staff Source: National statistical offices and World Bank staff estimate estimate Growth is accelerating supported by strong domestic demand 19 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 a drop in tourist overnight stays and industrial recorded increased levels of public spending production. Growth for the year is forecast to on wages, placing additional pressure on slow to 3.4 percent, down from 6.3 percent public finances and raising the issue of the in 2023. sustainability of consumption-driven growth. One challenge with wage increases is that the Economic growth in the WB6 region WB6 region is lagging in productivity growth is diverging, with Albania, Serbia, (as discussed in the RER Spring 2025). The Montenegro, and Kosovo enjoying strong Box 2.1 discusses human capital’s contribution growth driven by consumption and to productivity growth and options to investment, while Bosnia and Herzegovina improving it. and North Macedonia face slower growth. At the regional level, consumption is expected Investment is recovering in 2024 after its to be the main driver of economic growth negative contribution to growth in the in 2024, supported by rising real incomes, previous year. Unlike 2023, investment easing inflation and an increased employment. is projected to contribute positively to Higher wages are playing a key role in growth adding 2.2 pp in 2024 reversing a boosting consumption activity across the WB6 negative contribution of 0.8 pp in 2023. region, as moderating inflation supports real Serbia and Albania stand out for their disposable incomes. As part of governments’ investment growth. In Serbia and Albania, plans to address the cost-of-living crisis, in investment growth is expected to accelerate 2024 several countries (Kosovo, Bosnia and significantly, contributing 2.9 pp and 2.6 pp Herzegovina, and North Macedonia) saw an to growth, respectively (up from -0.6 and increase in minimum wages. In other countries, 0.8 pp, respectively, in 2023). In Serbia, this improving labor market indicators are also improvement is driven by a strong performance contributing to robust consumption activity. in net FDI and by government spending on For example, in Albania, Montenegro, and capital projects, including preparations for Serbia, improving labor market indicators— EXPO 2027. In Albania, investment growth such as increasing employment and declining is supported by increased construction activity unemployment rates—are expected to fuel and rising credit growth and is also reflected consumption activity. Consumption is in positive business sentiment indicators. projected to contribute 3.4 percentage points In Bosnia and Herzegovina, Kosovo, and (pp) to economic growth in Albania and Serbia Montenegro higher public investment is also and 3.9 pp in Montenegro, while in Kosovo driving growth. However, in North Macedonia consumption is estimated to contribute 4.6 the contribution of investment is expected pp to growth, the largest increase in the WB6 to remain muted (0.5 pp) due to delays in region. In Bosnia and Herzegovina, while highway construction and tight monetary total employment increased, unemployment conditions. rate went up as well as more people entered labor market. In North Macedonia, total Trade (net exports of goods and services) is employment remained almost unchanged, and projected to detract from growth in 2024, youth unemployment stayed stubbornly high, with a negative contribution of 2.1 pp. In suggesting the need for further job growth. all six WB6 countries trade is expected to Such trends are partially explaining the lower weigh on growth, Albania, Kosovo and Serbia impact of consumption on growth compared facing the largest negative impacts (of 2.5 pp with the rest of the region, with consumption or more) (Figure 2.3). This marks a shift from contributing an estimated at 2.7 pp and 2.0 2023, when trade contributed positively to pp in Bosnia and Herzegovina, and North regional growth, though this was driven by Macedonia, respectively. All WB6 countries three countries, North Macedonia, Albania, 20 Growth is accelerating supported by strong domestic demand RETAINING THE GROWTH MOMENTUM and Serbia; Montenegro had nearly zero growth in Bosnia and Herzegovina, North contribution of trade to growth, and Kosovo a Macedonia, Montenegro, and Kosovo. In negative contribution. The projected negative Montenegro, where tourism is a vital part of the contribution of trade to growth in 2024 economy, overnight stays fell by 4 percent in reflects the anticipated sluggish performance due to a weaker winter season. Construction is of the EU, and especially Germany, for the also a major growth driver in Albania, Kosovo, year. Looking at changes in trade for the and Serbia, supported by increased public WB6 region, Albania, Kosovo and Bosnia and capital expenditures and funds from the EU’s Herzegovina are expecting improvements in New Reform and Growth Facility. Following a merchandise trade relative to GDP in 2024, decline in 2023, Serbia’s industrial production while all countries except North Macedonia has shown resilience to external challenges and are expecting a deterioration in services trade recorded growth in H1 2024, contributing an relative to GDP in 2024 (Figure 2.4). estimated 0.7 pp to Serbia’s annual growth. The contribution of agriculture to growth On the production side, the service sector remains limited across all WB6 countries. In remains the main driver of growth across Serbia, a drought during the summer of 2024 the WB6, while manufacturing continues may significantly impact agriculture, the food to struggle in the context of weak Eurozone industry, and exports, ultimately having a growth, particularly in Germany. Strong retail negative effect on annual growth. sales and catering are key drivers of services FIGURE 2.3. FIGURE 2.4. Trade is expected to be a drag on growth in …driven largely by a reduction in services 2024 in all WB6 countries… Net services exports as share of GDP Net exports of goods and services, percentage point contribution to GDP growth Exports Imports Net Exports 2019 2020 2021 2022 2023 2024e 24.2 6.0 23.7 4.2 25.0 4.0 2.4 2.2 20.0 16.9 2.0 16.3 16.1 0.2 0.3 0.2 0.0 15.0 12.5 11.6 11.3 -2.0 -1.5 8.1 10.0 -2.4 7.4 6.5 -4.0 -2.9 -3.0 5.4 4.3 4.2 -4.9 5.0 -6.0 -8.0 -6.7 0.0 ALB BIH KOS MKD MNE SRB A LB B IH KO S MKD MN E S RB W B6 Source: National statistical offices and World Bank staff Source: National statistical offices and World Bank staff estimate estimate Growth is accelerating supported by strong domestic demand 21 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Box 2.1: How can the WB6 countries improve their human capital outcomes? Recent evidence from an extension of the Human Capital Index If current growth projections hold, it will take many years for WB6 countries to graduate from middle-income status. Despite recent gains, most of the WB6 countries lag behind EU countries in human capital outcomes. Development economists have long emphasized that the development of countries is closely tied to its stock of human capital, understood as the productive capacity of individuals.. But this capacity is conditional on the environment in which individuals live. In the WB6 region, the nature of labor demand is such that full basic education is no longer enough to ensure a productive employment. Moreover, in aging societies such as those in the WB6 region, adult health plays a key part the long-term productivity of workers. To assess the productivity of human capital in middle-income countries, an extension of the World Bank’s Human Capital Index, called the Europe and Central Asia Human Capital Index (ECA-HCI), has been proposed. 1 This index encompasses quality-adjusted years of higher education and the prevalence of three adult health risk factors (smoking, drinking, and obesity, all of them risk factors for noncommunicable diseases such as heart diseases, cancer, and diabetes, among others). This extension can help countries in assessing their readiness to avoid the middle-income trap and transition to high-income status, where productivity, more than pure investment, and innovation, rather than simple technological adoption, are the engines of growth. The citizens of the WB6 countries could see their productivity increase by 48 percent if they achieved the education and health indicators of the best performer in the EU. The average WB6 ECA-HCI value is at 0.396 (Figure 2.5), which implies that its citizens have a productivity that is only 39.6 percent of the productivity achieved in a best education and best health scenario (i.e., 3.5 years of higher education and zero prevalence of adult health risk factors). If WB6 countries were to close the gap with the EU’s best performer (Ireland, with an ECA-HCI value of 0.587), their citizens’ productivity would increase by 48 percent. The average WB6 value is behind the average for ECA2 (0.42) and the average for the EU (0.514). Within the WB6, North Macedonia has the lowest value at 0.359, which is also the second-lowest value in the whole ECA region, only behind Tajikistan. The highest value in the sub-region is found in Serbia, at 0.443, ahead of Bulgaria and Romania, but behind the rest of the EU countries. 1 Demirgüc-Kunt and Torre (2022). Measuring Human Capital in Middle Income Countries. Journal of Comparative Economics. Vol. 50, n.4: 1036-1067 2 ECA (Europe and Central Asia) corresponds to the following countries: Albania, Armenia, Azerbaijan, Belarus, Bosnia and Her- zegovina, Bulgaria, Croatia, Georgia, Kazakhstan, Kosovo, Kyrgyz Republic, Moldova, Montenegro, North Macedonia, Poland, Romania, the Russian Federation, Serbia, Tajikistan, Türkiye, Turkmenistan, Ukraine, and Uzbekistan. 22 Growth is accelerating supported by strong domestic demand RETAINING THE GROWTH MOMENTUM FIGURE 2.5. ECA-HCI - Western Balkans, ECA and EU 0.60 0.514 0.50 0.443 0.401 0.415 0.420 0.396 0.40 0.359 0.362 ECA-HCI 0.30 0.20 0.10 0.00 MKD BIH Western ALB MNE ECA SRB EU Balkans Source: Demirgüc-Kunt and Torre (2022). Note: Data correspond to 2020. The value for Kosovo is not available due to data limitations. The values for the WB6, ECA, and the EU correspond to the simple average of the countries they include. TABLE 2.1. Prevalence of adult health risk factors and indicators of higher education Albania Bosnia and Kosovo Montenegro North Serbia Western ECA EU Herzegovina Macedonia Balkans Adult health risk factors (prevalence among adult population, in %) Obesity 22.3 19.4 21.5 24.9 23.9 23.5 22.6 20.0 16.6 Smoking 28.9 38.1 36.4 35.4 35.0 36.0 35.0 27.8 25.5 Heavy Episodic 22.9 22.7 8 26.9 26.5 32.9 23.3 19.9 20.9 Drinking Higher education indicators Attainment 23.5 21.0 32.3 34.0 29.9 33.3 29.0 33.2 42.9 (% of pop age 30-34 with tertiary degree) University 6.9 5.5 n.a. 1.5 7.3 22.6 8.7 12.5 28.8 quality score (0-100) Source: Data on obesity, smoking, and heavy episodic drinking are from the European Health Interview Survey, Health Equity and Financial Protection Indicators, the World Health Organization, Morina and Brestovci (2022), and HIbell et al. (2012). At- tainment data were calculated from the European Union Statistics on Income and Living Conditions and household surveys. University quality score from Demirgüc-Kunt and Torre (2022). Note: Data correspond to 2022 or latest available year. The value for the university quality of score is not available due to data limitations. The values for the WB6, ECA, and the EU correspond to the simple average of the countries they include. The university quality score measures, in a scale from 0 to 100, the average quality of universities in each country. The value of 100 corresponds to the notionally highest ranked university of the world. The score is calculated using data from six university rankings (Times Higher Education, QS, US News, ARWU “Shanghai” index, CWUR, and U-Multirank). Growth is accelerating supported by strong domestic demand 23 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 On the health side, the relatively lower productivity of the WB6 citizens is explained by a high prevalence of adult health risk factors, above ECA and EU averages (Table 2.1). The average incidence of obesity among the adult population in the WB6 is 23 percent, compared with 20 percent in ECA and 17 percent in the EU. The average share of adult smokers in the WB6 is 35 percent, compared with 28 percent in ECA and 26 percent in the EU, while the prevalence of heavy episodic drinking among adults in the WB6 is at 26 percent, compared with 20 percent in ECA and 21 percent in the EU. Across the WB6 region, the prevalence of smoking and heavy drinking is substantially higher among men than women, while the prevalence of obesity is slightly higher among women. The largest gaps in the productivity of human capital are observed in education. International student tests3 have shown that scores in Albania, Kosovo, and North Macedonia were among the lowest in the region. Beyond the low basic education outcomes, the same weak performance is equally observed in higher education, where quality is low. The average university quality score in the WB6 countries is 8.7 (on a scale from 0 to 100, where 100 corresponds to the notionally highest ranked university in the world4), while the average for ECA is 12.5, the average for the EU is 28.8, and the world’s leader (Singapore) has a score of 50.3. The region’s performance in this indicator is only buoyed by Serbia, which has an average university quality score of 22.6, while the remaining countries in the WB6 seeing considerably lower scores. Notably, the quality of higher education is well below other countries with similar quality of basic education. Higher education attainment is also low in the WB6 countries: on average, 29 percent of the adults aged 30–34 have a university degree, compared with 33 percent in ECA and 43 percent in the EU. Improving the quality of higher education is fundamental for countries to transition to an innovation- led growth model, which will lead them to achieve high income status. FIGURE 2.6. Higher education is underperforming in the WB6 and ECA 50 Western Balkans Note: This graph plots, for every country Quality of higher education (University quality score) with available data, the quality of higher ed- ECA ucation (vertical axis) and the quality of ba- Rest of the world sic education (horizontal axis). The black line 40 indicates the linear fit between both vari- ables. The dashed horizontal line indicates 30 the average quality of basic education in the country sample, while the dashed vertical line indicates the average quality of higher SRB education. The quality of basic education 20 is proxied by the average harmonized test score by country as published in the latest version of the World Bank Human Capital 10 MKD ALB Database. The quality of higher education is BIH proxied by the aggregate university quality MNE score as calculated by Demirgüç-Kunt and 0 Torre (2022). Light orange points indicate 300 400 500 600 countries in ECA, while dark orange points Quality of basic education (HLO score) indicate countries in the Western Balkans. Sources: Demirgüç-Kunt and Torre (2022); Human Capital Database of the World Bank (2022). 3 Such as the Program for International Student Assessment (PISA), the Progress in International Reading Literacy Study (PIRLS), and the Trends in International Mathematics and Science Study (TIMMS). 4 No single university tops all the rankings -each of the six rankings has a different top university-, so the maximum score corre- sponds to a notional university. 24 Growth is accelerating supported by strong domestic demand RETAINING THE GROWTH MOMENTUM The productivity of human capital is also affected by migration (see RER Spotlight). In the past 30 years, the stock of migrants from the WB6 countries has more than doubled, reaching almost 5 million. While emigration reduces the stock of human capital in a country, it can also affect its productivity, both in a positive and in a negative sense. On the one hand, emigration of the most talented and healthy workers raises the concern of a brain drain and an overall decrease in the productivity of the workforce that remains in the country. While highly educated individuals are increasingly leaving the region, the average educational profile of the WB6 emigrants shows generally low levels of education: only one in six WB6 migrants has tertiary education, below the rates of the non-migrant population. On the other hand, emigration of talented and healthy workers results in a higher flow of remittances and in potential investments in human capital in the origin country. Multiple channels are behind these mechanisms. The prospects of high wages abroad drive individuals to invest in their own education even if they do not end up migrating.5 There is also evidence that households that receive remittances tend to invest more in education of the children than households that do not receive them.6 Some migrants also accumulate human capital while abroad.7 However, well designed migration policies need to be in place to allow all actors to fully benefit from international mobility and limit its potential risks to the human capital of origin countries. In this regard, higher education institutions play an important role in ensuring that the benefits of migration accrue to both origin and destination countries. What should countries do to improve the productivity of their human capital? • Get the basics right: according to a recent World Bank analysis8, some of the most cost-effective interventions can deliver the equivalent of three years of high-quality education for as little as $100 per child. The three most cost-effective approaches are: targeted information campaigns on benefits, costs, and quality, together with a reinforcement of education management information systems; interventions to target teaching instruction by learning level rather than by grade (like individual tutoring and digital personalized learning9); and improved pedagogy in the form of structured lesson plans with linked student materials, teacher professional development (emphasizing pre- service training, as well as a competitive teacher recruitment process )and monitoring. • Invest in prevention and primary health care while soliciting good behaviors and healthy practices. These could comprise incentivizing targeted performances at the primary care level - e.g., early identification of risk factors, counseling on how to reduce and control these risks, proper treatment, and monitoring of the conditions that lead to acute cases (diabetes, hypertension, etc.). Governments could also introduce policies that prevent unhealthy behaviors, like excise taxes on cigarettes, sugar-sweetened beverages, alcohol, bans on smoking in public places, and similar measures10. 5 Abarcar and Thehoarides, 2024. 6 USAID, 2010; Oruc, Jackson and Pugh, 2018. 7 Eurostat, 2024. 8 Angrist et al., 2020. “How to Improve Education Outcomes Most Efficiently? A Comparison of 150 Interventions Using the New Learning-Adjusted Years of Schooling Metric.” Policy Research Working Paper 9450. World Bank: Washington, DC. 9 World Bank 2024b. Investing in People and Enhancing Innovation and Growth through Education in Europe and Central Asia. Washington, DC. 10 World Bank 2020. Fall 2020 ECA Economic Update: COVID-19 and Human Capital. World Bank: Washington, DC Growth is accelerating supported by strong domestic demand 25 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 • Reform curricula aligned with regional quality assurance standards and accreditation. WeBa countries are encouraged to align their quality assurance systems with EU standards to ensure quality and relevance of their higher education programs. This includes internal quality assurance processes within institutions and external quality assurance mechanisms conducted by independent agencies. • Factor in re-skilling and skills upgrading due to the changing nature of work. There is an urgency to upgrade higher order skills training in Science, Technology, Engineering and Mathematics (STEM), and research and innovation. Across the 6 countries, the green transition and the changing nature of work play a key role in determining the new sets of skills demanded in the labor market. WeBa countries need to invest in making sure that workers can adapt to frequent changes in skill requirements – an important skill in itself. This will be particularly important as brown jobs give way to green jobs in the region, and also to ensure that an aging workforce remains healthy and productive. • Consider regional engagements/projects. In many fields and interdisciplinary areas, regional endeavors and projects help to achieve economies of scale and conduct leading- edge scientific research that many countries would be unable to do on their own for lack of adequate financial and scientific resources. Regional collaboration in higher education can take two basic forms11: coordinated regional activities -like enhancing the external quality assurance of universities and supporting the establishment of internationally recognized indicators of quality- and integrated regional activities -like the establishment of regional centers of excellence for research and graduate education and joint degree programs. International examples include the establishment of a resilient and sustainable ASEAN (Association of Southeast Asian Nations) Higher Education Space12 by East Asian countries. The Western Balkans can explore such a model of cooperation and connect with other countries within the EU and beyond. 11 Linden, Arnhold, and Vasiliev 2008. “From Fragmentation to Cooperation: Tertiary Education, Research, and Development in South Eastern Europe 12 https://asean.org/asean-roadmap-2025-to-realise-a-common-higher-education-space-in-southeast-asia/ 26 Growth is accelerating supported by strong domestic demand RETAINING THE GROWTH MOMENTUM 3. Solid growth is driving employment in 202413 The WB6 region’s labor markets further mid-2021, underscoring the magnitude of the improved in 2024, with employment levels region’s recovery. In Albania and Montenegro, reaching historical highs across WB6 the employment rate (15+) is above the EU27, countries, although the employment growth and the employment rate increased most in is decelerating. The growth recovery that Montenegro in the first half of 2024 (Figure began in 2021, led by demand for transport, 3.2). In Kosovo, despite recent gains, only an trade, tourism, and a booming ICT industry, estimated 37.1 percent of the working-age brought employment to new highs, far population is employed. surpassing pre-pandemic levels and adding over 390,000 jobs since end-2019. Between Labor shortages continue being among the mid-2023 and mid-2024 alone, an additional key concerns for businesses (Box 3.2). These 114,000 jobs were created in the region, of shortages have fueled an increase in imported which Serbia showed the largest nominal gains foreign workers (see Spotlight) and a widening (48,400), followed by Bosnia and Herzegovina of the skills mismatches that firms in the region (39,000). Average annual employment growth have been reporting for some time. To enable for the region has been 1.8 percent in 2024 cross-border labor mobility, Albania, North (Figure 3.1), declining from 2 percent in 2023. Macedonia, and Serbia launched a single labor market on March 1, 2024, as part of the Open Employment rates have increased in most Balkans initiative. The joint labor market aims WB6 countries, with the average reaching to simplify the procedures for free access to these a historical high of 48.5 percent in June countries’ labor markets. The joint protocols 2024.14 Although still lower compared allow citizens from the three countries to travel with 54.4 percent in the EU27, the gap in freely to any of these countries with a valid employment rates is narrowing, given the biometric ID for work, eliminating the need increase in the WB6 countries of 6 pp since for work permits. Furthermore, electronic FIGURE 3.1. FIGURE 3.2. Continued employment growth in 2024... ...has led to historically high employment rates Two-quarter averages, yoy employment growth, percent 15+ years, percentage change H1 2024–H1 2023 ALB MKD SRB WB6 WB6 H1 2024 1.0 BIH- rhs MNE-rhs KOS-rhs H1 2023 6 30 KOS H1 2024 1.4 25 H1 2023 4 20 BIH H1 2024 1.2 15 H1 2023 2 10 5 MKD H1 2024 0.2 0 H1 2023 0 -5 SRB H1 2024 1.2 -10 H1 2023 -2 -15 -20 MNE H1 2024 2.4 -4 -25 H1 2023 ALB H1 2024 0.3 Jul-21 Jul-22 Jul-23 Sep-21 Nov-21 Mar-21 Jan-22 Jan-23 Jan-24 Sep-22 Sep-23 May-21 Nov-22 Nov-23 Mar-22 Mar-23 Mar-24 May-22 May-23 May-24 H1 2023 50 30 40 56 36 46 58 38 48 52 54 32 34 42 44 Source: National statistics offices and World Bank staff esti- mates. 13 This analysis was affected by (1) delayed publishing of Labor Force Survey (LFS) data in Kosovo and Albania, and by (2) a sampling revision in Bosnia and Herzegovina, and Montenegro in 2021-22 that reduced comparability with previous LFS data. Using administrative employ- ment and unemployment in Albania, and tax administration data for Kosovo helped provide an approximate picture of the labor market in H1 2024. 14 The employment rate is the WB6 region’s simple average. Solid growth is driving employment in 2024 27 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 services to businesses for registering workers The labor force participation rate has slightly will be available, and the e-government portals improved over the past year on a regional of the three countries will be inter-connected. level (Figure 3.4). The participation rate (for Permits can be obtained for up to two years, 15+ age groups) averaged 54.4 percent in H1 with the possibility of further extensions. 2024, an increase of 0.9 pp since H1 2023. Gains in labor force participation have been All sectors have contributed to the labor observed in Bosnia and Herzegovina, Kosovo, market recovery (Figure 3.3). A rebounding Montenegro, and Serbia. In June 2024, tourism sector has boosted employment, female participation rate for the WB6 region followed by a rise in the trade and ICT sectors, improved to 45.3 percent, respectively, which is as well as in transport in mid-2024. The a historical high. The labor force participation construction sector has also seen an increase in rate in Montenegro of 63.8 percent is the employment across WB6 countries, with the highest among the WB6 countries, with men exception of North Macedonia. Apart from participating at a rate of 71.4 percent. The Serbia and Montenegro, employment growth lowest ratio of population participating in the in the agriculture sector was positive, labor market is seen in Kosovo, at only 42.7 potentially responding to increased agricultural percent, which is nonetheless an improvement subsidies aimed at containing the impact of of 2.5 pp from 2023. The participation rate food inflation and helping to boost import dynamics partly reflects a decline in the substitution. In June 2024, the strongest working age population of around 45,200 employment growth in the region was in the for the WB6 region as a whole, with most of construction (4.4 percent, yoy and agriculture the decline observed in Kosovo and Serbia, by (2.6 percent) sectors, with the slowest growth 23,700 and 26,700, respectively. This reflects in industrial employment and public both population aging and migration outflows administration. The energy sector in (in Kosovo this was led by visa liberalization Montenegro increased employment by double and more relaxed work permitting in some EU digits compared with 2023, similar to countries, in particular Germany). employment in the construction and ICT sectors in Kosovo. FIGURE 3.3. FIGURE 3.4. Construction and services created new jobs More people joined the WB6 labor force Employment level, 15+ years, percent, annual change Participation rate, percent of population aged 15+ Q4 22 H1 2024 H1 2023 Q1 23 9.7 Q3 23 MNE 7.9 Q2 23 ALB 6.8 Q4 23 Q1 24 5.4 Q2 24 SRB 4.4 3.5 WB6 2.7 2.6 2.7 2.5 2.5 2.3 2.1 1.7 1.6 1.6 1.5 1.4 1.2 0.8 0.9 1.0 1.0 0.8 0.8 0.7 0.7 MKD 0.6 BIH -0.4 -1.6 -1.4 -2.1 KOS -2.1 -2.3 -3.6 General Agriculture Industry Construction Services Government 0 10 20 30 40 50 60 70 Source: National statistics offices and World Bank staff esti- Source: National statistics offices and World Bank staff esti- mates. mates. Note: Employment growth is weighted average. 28 Solid growth is driving employment in 2024 RETAINING THE GROWTH MOMENTUM FIGURE 3.5. Unemployment rates have declined further in the WB6 in 2024 Unemployment rate, 15+ years, percent, and H1 2024–H1 2023, percentage change H1 2024 -0.6 SRB WB6 H1 2023 H1 2024 -1 H1 2023 H1 2024 -0.9 ALB H1 2023 H1 2024 -2.6 MKD MNE H1 2023 H1 2024 -0.5 H1 2023 H1 2024 1.8 KOS H1 2023 H1 2024 0.1 BiH H1 2023 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 Source: National statistics offices and World Bank staff estimates. Unemployment has declined across all WB6 The broad-based recovery in employment countries, with the exception of Kosovo, has also benefited vulnerable groups and the unemployment rate for the WB6 over the past two years, but some of these region reached 11.3 percent in June 2024. gains are reversing. By mid-2024, youth There were 783,000 people unemployed in unemployment (15–24 years old) increased the region, or 52,900 people less than a year to 25.6 percent, up by 2.7 pp yoy. There are ago. Serbia and Albania recorded the largest over 147,000 young people without jobs in nominal declines on an annual basis, partly the WB6 region, a cohort that is in the prime explained by the rise in employment, but also working age (Box 3.1). For example, despite a rise in inactivity in the case of Albania. While improvements, the youth unemployment rate Montenegro observed the largest decline in in Bosnia and Herzegovina—a country with the unemployment rate (by 1.6 pp), Serbia one of the largest diasporas (see Spotlight)— attained the lowest rate of 8.2 percent in June is the highest in the WB6 region, at above 30 2024 (Figure 3.5). percent. In Montenegro, North Macedonia, and Kosovo, the number of young jobseekers has increased, in the latter as eligibility to participate in the Youth Guarantee Program that subsidizes wages for 6 months requires a registration at the employment bureau. Solid growth is driving employment in 2024 29 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Box 3.1: Who are the unemployed in the Western Balkans? In 2023, youth unemployment and unemployment rates among prime-age workers (25–54 years old) in the WB6 countries were double the average unemployment rate of the EU27 for same age categories, a significant missed opportunity for human capital to contribute to growth. All countries had youth unemployment rates (15–24 years old) far exceeding 20 percent, except for Kosovo (17.2 percent) where it was slightly above the EU27 average. The unemployment rate for people in the prime working age (25–54 years old) was also double the EU27 average (with Montenegro having the widest gap). For the oldest age category (55–64 years old), the gap was not that wide, except in Bosnia and Herzegovina, and North Macedonia (Figure 3.6). FIGURE 3.6. Unemployment rates still compare poorly with the EU27, especially for the youngest and prime age workforce Unemployment rates by age cohorts, percent EU 15-24 at 14.5% EU 25-54 at 5.5% EU 55-64 at 4.6% 35 30.1 29.3 30 25.6 25.0 25 23.3 20 17.2 15 14.3 12.6 12.8 10.3 10.7 10 9.5 8.9 8.2 7.1 6.2 6.9 5.5 5 0 25-54 15-24 15-24 25-54 55-64 15-24 25-54 55-64 15-24 25-54 55-64 15-24 25-54 55-64 15-24 25-54 55-64 55-64 ALB BIH KOS MKD MNE SRB Source: National state statistical offices and the World Bank staff estimations. Age, educational attainment, and gender played an important role in shaping the differences in unemployment rates between the Western Balkans and the EU27 in 2023 (Figure 3.7). In the lowest educated workforce group, Albania had the lowest unemployment rates both by age and gender, even outperforming the EU27 outcomes. At the other extreme, Bosnia and Herzegovina had the worst employment prospects, especially for younger women with low education. In Kosovo, women in the 55–64 age cohort were particularly affected by unemployment, in contrast to the rest of the WB6 countries. Serbia, on the other hand, had the greatest homogeneity in terms of gender. Looking at those with secondary school education, the WB6 region appears more uniform, with generally higher unemployment rates than for the EU27, and with younger workers of both genders most affected. For the group with tertiary education, the youth unemployment rate was again the main issue, especially for females in Montenegro, Serbia, and Bosnia and Herzegovina, and males in North Macedonia and Kosovo. 30 Solid growth is driving employment in 2024 RETAINING THE GROWTH MOMENTUM FIGURE 3.7. The highest unemployment rates are found among younger women with only primary educational attainment Low education Medium education 70 40 60 35 50 30 25 40 20 30 15 20 10 10 5 0 0 EU 27 ALB BIH KOS MKD MNE SRB EU 27 ALB BIH KOS MKD MNE SRB High education 60 Females 15-24 50 Males 15-24 Females 25-54 40 Males 25-54 30 Females 55-64 Males 55-64 20 10 0 EU 27 ALB BIH KOS MKD MNE SRB Note: Low educational attainment comprises less than primary and primary education; medium educational attainment includes vocational after primary and secondary education; high educational attainment stands for tertiary education. The estimates for females in the 15–24 age group with low educational attainments and for males in the 15–24 age group with high educational attainments for Montenegro were estimated using the working age (15–64) population structure. Sources: National statistical offices and Eurostat. There are persistent unemployment hotspots within countries. While the unemployment gap—the difference between the highest and lowest unemployment rates—within WB6 countries has decreased, the disparities remain striking. The most prominent example is seen in Montenegro which, in 2023, had regions with both the highest (northern region) and the lowest (coastal region) unemployment rates among the WB6 countries, suggesting very low labor mobility. Albania and North Macedonia present wide unemployment gaps, both around 16 pp in 2023. The lagging regions deserve a deeper analysis of the factors behind being unemployment hotspots at times of serious labor shortages. FIGURE 3.8. Regional unemployment rate disparities persist at times of serious labor shortages 35.0 31.9 30.0 25.0 21.8 20.921.222.6 20.0 16.717.6 15.0 15.0 11.1 11.9 11.2 10.8 10.410.611.0 10.1 12.8 10.0 5.7 6.66.96.97.0 7.2 8.0 6.26.6 7.1 9.09.8 EU average: 5.0 3.1 6.1 0.0 Berat Kosovo Gjirokaster Southeast region Pelagonia region Vardar region Southwest region Polog region Northeast region Coastal region Central region Northern region Belgrade Vojvodina Šumadija and Western Serbia Southern and Eastern Serbia Shkoder Fier Diber Vlore Durres Kukes Korce Tirane Elbasan Lezhe RS FBiH East region Skopje region ALB BIH KOS MKD MNE SRB Source: National statistical offices and Eurostat. Solid growth is driving employment in 2024 31 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 FIGURE 3.9. Note: For 2024, the average wage Replacement rates are higher than in the EU27 refers to H1 for Albania, Bosnia and Herzegovina, North Macedonia, Minimum to average wage ratio, percent Montenegro, and Serbia. The average 2017 2018 2019 2020 2021 2022 2023 2024* wage for 2023 and 2024 for Kosovo 65% were estimated from the administra- tive tax data. 60% 0.57 0.55 0.54 0.54 0.54 55% 0.51 0.51 0.50 0.48 50% 0.47 0.46 0.46 0.45 0.45 45% 40% 35% 0.30 30% ALB BIH KOS MKD MNE SRB WB6 EU Aver age Average Source: National statistics offices and World Bank staff estimates. Real wages have increased in the WB6 as low-wage workers’ earnings increase more countries in the period 2023–24, as compared with the average worker. From 2017 inflation has declined, and minimum and to the beginning of 2024, this rate increased public sector wages have increased, while in most WB6 countries. In H1 2024, most labor markets have remained tight (Box WB6 countries increased their minimum 3.2.). In 2023, real wages increased by 8.4 wages significantly, while Kosovo doubled its percent, on average, across the WB6 countries, minimum wage in August 2024 to €340, and far surpassing productivity growth of just 0.2 Montenegro raised its minimum wage to €670 percent. This increase continued in H1 2024, from October 2024. An increasing replacement with real wages increasing on average by 8.3 ratio can be viewed positively if it reflects a percent in H1, ranging from 2.7 percent deliberate policy to improve the livelihoods (Montenegro) to 11.6 percent in North of the lowest-paid workers. However, it could Macedonia and Serbia. The WB6 region’s also signal underlying economic challenges if average replacement rate—calculated as the it reflects stagnant or slow growth in average minimum wage to nominal average wage wages, potentially due to high informality, ratio—is increasing at a higher pace than in the low productivity, or demand for lower-quality EU27 due to a sharp rise in minimum wages lower-paid jobs. (Figure 3.9). This reduces income inequality, 32 Solid growth is driving employment in 2024 RETAINING THE GROWTH MOMENTUM Box 3.2: Does the Phillips Curve hold true in the Western Balkans? The Phillips curve entails a negative correlation between nominal wage growth and the unemployment rate,15 meaning that low unemployment relates to accelerated nominal wage growth. In simpler terms, wages tend to increase more quickly when the labor market is tight, and they rise more slowly when the labor market is slack. Understanding the drivers of unemployment and wages is important not only for macroeconomic policy, but also for prospects of reducing income inequality and enhancing workers’ security. Examining the relationship between wages and unemployment in the WB6 region suggests that the Phillips curve holds for most WB6 countries. Figure 3.10 plots the unemployment rate and the growth rate of real wages for each country in the region between 2017 and 2023. In the analysis, real wages were used instead of nominal wages to analyze the relationship between unemployment and wage dynamics as real wages account for inflation and provide a clearer picture of workers’ purchasing power. For the period 2017–2023, real wage growth and two-quarter lagged unemployment rates are negatively correlated,16 with the resulting regression line exhibiting a negative slope (with statistically significant 0.32 coefficient), supporting the applicability of a downward sloping Phillips curve. This is the case for all of the WB6 countries, with the exception of North Macedonia. FIGURE 3.10. Real wage growth and unemployment in the Western Balkans (2017–2023) 2023Q4 Real wage unemployment 14% 2018 2023Q2 2019 12% 2020 2023Q3 2019Q4 2021 2023Q4 10% 2019Q3 2023Q3 2022 2023Q4 2023Q4 2023Q2 2020Q1 2023 2020Q1 8% 2020Q4 2020Q32023Q4 2020Q2 2023Q3 2019Q2 2020Q3 2019Q4 Linear (Real wage unemployment) 2019Q1 2018Q1 2021Q2 2023Q3 Real wage growth t 2020Q2 6% 2021Q1 2021Q4 2023Q2 2020Q3 2020Q4 2022Q1 2023Q2 2021Q1 2020Q2 2021Q2 2019Q3 2023Q3 2021Q3 2021Q4 2021Q3 2021Q1 2018Q4 2018Q2 2023Q1 2019Q4 2020Q4 2018Q3 2019Q3 2023Q12022Q1 2020Q1 4% 2022Q2 2019Q3 2021Q2 2019Q2 2021Q1 2019Q2 2021Q2 2019Q2 2019Q1 2018Q1 2023Q2 2019Q1 2018Q4 2022Q3 2018Q4 2018Q1 2022Q4 2019Q1 2020Q4 2021Q3 2% 2023Q1 2022Q3 2022Q1 2020Q2 2020Q4 2019Q3 2020Q3 2020Q2 2021Q3 2021Q4 2018Q3 2018Q2 2018Q1 2022Q2 2019Q4 2018Q4 2022Q1 2020Q1 2019Q42020Q1 2020Q3 2018Q2 2018Q3 2018Q2 2018Q3 2019Q1 2019Q2 2021Q1 2022Q4 2021Q4 0% 2023Q1 2022Q4 2022Q1 8% 10% 12% 14% 2022Q2 16% 18% 20% 2021Q3 2021Q2 22% 2022Q2 2018Q4 2021Q4 -2% 2018Q3 2022Q3 2022Q3 2018Q1 2022Q3 2018Q2 2022Q2 2022Q4 2022Q4 2023Q1 -4% Unemployment rate t-2 Note: Kosovo is not presented on the figure given no quarterly wage data are available. Source: National state statistical offices and the Bank staff estimations. 15 https://www.jstor.org/stable/2550759 16 The lags chosen are based on the comparison of the resulting from the regressions of real wage growth on unemployment rate with different lags. The highest is associated with two lags. Solid growth is driving employment in 2024 33 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Is such real wage growth sustainable given that it has surpassed productivity growth since 2015? In the WB6 region, wage growth has not reflected productivity growth since 2015, and recent wage increases have widened the wage-productivity gap. This gap is most notable in Albania and North Macedonia (Figure 3.11). Key factors that have contributed to this are automatic increases of minimum wages in several countries, strong public sector wage bargaining, and a record shortage of workers, as indicated by the Balkan Business Barometer in 2024. For the period 2019–2024, the Balkan Business Barometer suggests that labor shortages are trending from being a minor toward being a moderate business obstacle (Figure 3.12). FIGURE 3.11. FIGURE 3.12. Average real wage and productivity Labor shortages as business obstacles growth, 2015–2023 in the WB6 countries, 2019–2023 Real wage growth Scale: 1 - major obstacle, 2 - moderate obstacle, 3 - Productivity growth per worker Productivity growth per hours minor obstacle, 4 - no obstacle. 3.5 Region A LB 3% B IH 3 KOS MKD 2% 2.5 MN E S RB 2 1% 1.5 0% 1 ALB B IH KOS MN E MKD S RB 2019 2020 2021 2022 2023 2024 Note: Productivity growth per worker and per hour Source: Regional Cooperation Council’s Balkan Business estimates are obtained using number of employees and Barometer 2023. average hours worked per week, respectively, from Labor Force Survey (LFS) and real GDP. Source: National state statistical offices and the World Bank staff estimations. 34 Solid growth is driving employment in 2024 RETAINING THE GROWTH MOMENTUM 4. Closing gender disparities can support stronger poverty reduction in the region Poverty reduction in the Western Balkans The World Bank’s new global prosperity has continued its downward trend but at a gap17 measure—an indicator of inclusive slower pace than in the pre-pandemic growth—also highlights the significant period. Up to 2019, poverty decreased by over challenges of boosting inclusive growth. 3 percentage points annually, but between Poverty reduction is not the only indicator 2022 and 2025, this rate is estimated to fall to of societal progress. To capture the progress roughly 1 percentage point annually. This and equity aspects of economic growth, the slower reduction is attributed to a combination World Bank has recently introduced the of slower economic growth in the region and Global Prosperity Gap, which captures how far significant increases in food and energy prices people’s incomes are from a global prosperity during 2022–23, which strained households’ standard, which is set at US$25 per person per purchasing power. In 2022, real wages declined day. This benchmark represents the average in all six countries in the Western Balkans. As income when countries transition from upper inflation started to decrease in 2023, with middle-income to high-income country status projections indicating a continued slowdown (World Bank, 2024).18 Specifically, the Global throughout the forecast period, this trend is Prosperity Gap is defined as the average factor expected to benefit lower-income households by which incomes need to be multiplied to significantly. As labor markets continue to bring everyone in a given group (for example, display positive signals across the region and the Western Balkans region) to the prosperity wages have risen during the 2023–24 period, it standard.19 In 2023, the incomes of the is expected that these developments could WB6 countries population would need to be further contribute to reducing poverty. multiplied by a factor of 2.1 to fully close the FIGURE 4.1. Poverty reduction has de-escalated in recent years 40 less than $6.85/day 2017PPP) Povertyheadcount (% ofpopulationlivingon 30 29.2 26.7 20 23.1 19.2 19.4 14.2 13.4 12.5 11.6 15.6 10.9 10 0 2016 2017 2018/ e 2019/ e 2020/ e 2021/ e 2022/ f 2023/ f 2024/ f 2025/ f 2026/ f Source: World Bank estimates and forecasts based on 2021 income data from the Survey of Income and Living Conditions (SILC) for Montenegro; 2019 for Albania and North Macedonia, 2021 for Serbia; and 2017 Household Budget Survey (HBS) for Kosovo. Note: Income and consumption measures from the SILC and the HBS, respectively, are not strictly comparable. Welfare is estimated in US dollars using 2017 PPPs. Due to a lack of comparable data, the regional estimate excludes Bosnia and Herzegovina (BiH). Forecasts are based on GDP per capita in constant LCU, e = estimate, f = forecast. 17 Find out more about the new prosperity gap indicator in this series of blogs (https://blogs.worldbank.org/en/developmenttalk/prosperi- ty-gap-proposed-new-indicator-monitor-shared-prosperity , https://blogs.worldbank.org/en/impactevaluations/can-we-have-welfare-in- dex-easy-understand-also-distribution-sensitive ) 18 World Bank. 2024. Poverty, Prosperity and Planet Report 2024. Washington, DC: The World Bank. 19 In other words, the Prosperity Gap measure is thus the average, across all people, of the ratio of individual incomes to the prosperity stan- dard. Closing gender disparities can support stronger poverty reduction in the region 35 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 regional prosperity gap. Within the region, Kosovo and Montenegro experienced the North Macedonia had the largest Prosperity largest improvement in the gap, the impact on Gap at 2.9, while Bosnia and Herzegovina had the regional trend was limited by their small, the lowest at 1.4. Albania and Serbia matched combined contribution to the overall index. the regional average, whereas Montenegro and Kosovo reported above-average gaps, at Boosting economic growth, increasing 2.4 and 2.7, respectively (Figure 4.2). The labor market participation of both men and Prosperity Gap in the WB6 countries, while women, and reducing gender disparities smaller than the average for the ECA region in labor market outcomes will be essential of 2.6 and considerably lower than the global to further increase incomes at the lower average of 5.1, remains much higher than EU end of the income distribution. Poverty and high-income countries such as Croatia reduction will likely remain muted during the (1.2) or Slovenia (0.7). forecast period, primarily due to structural labor market constraints related to low The WB6 countries have shown limited participation. This means that recent wage improvement in the prosperity gap in the increases in the region may not necessarily post-COVID-19 pandemic years. In 2019, translate into significant increases in the before the onset of the COVID-19 pandemic, welfare of households below the poverty line, the average Prosperity Gap for the Western because a significant share of these households Balkans stood at 2.3. However, its latest are characterized by long-term unemployment estimate is largely unchanged, with none of the or high levels of inactivity. In the short run, six countries in the region registering supporting labor market participation and significant gains. This is a concern for inclusive closing gender employment gaps can help growth because the Prosperity Gap gives address the high degree of vulnerability to greater weight to the incomes of the poor, such economic shocks of households in the WB6 that poorer households contribute significantly countries that was highlighted in the previous more to the gap than their better-off edition of the Regional Economic Report. counterparts (Kraay et al., 202320). Figure 4.3 Over the long term, the WB6 countries can shows each country’s contribution to the potentially reap significant gains from closing regional Prosperity Gap in 2023. Although gender employment gaps alone (see Box 4.1). FIGURE 4.2. FIGURE 4.3. Regional and country-specific Prosperity Contribution of each country to the Gap, 2019 and 2023 regional Prosperity Gap, 2023 100% 3.1 KOS , 3.1 Correspond to better outcomes) Prosperity Gap (Lower values 90% 2.9 MKD , 3.0 MKD , 2.9 MNE , 2.8 80% SRB.39% 2.7 KOS , 2.7 70% 2.5 ALB , 2.4 MNE , 2.4 60% 2.3 WB6 , 2.3 50% KOS.13% SRB , 2.2 WB6 , 2.1 2.1 SRB , 2.1 40% MNE.4% 1.9 ALB , 2.1 MKD.15% 30% 1.7 20% BIH.13% 1.5 BIH , 1.5 10% BIH , 1.4 ALB.16% 1.3 0% 2017 2019 2021 2023 2025 2023 Note: The plots show the regional and national Prosperity Gaps in 2019 and 2023 and their contribution in 2023. Source: using data from Kraay (2023) and Yonzan, Mahler, Lakner (2023). 20 Kraay,Aart C.; Lakner,Christoph; Ozler,Berk; Decerf,Benoit Marie A; Jolliffe,Dean Mitchell; Sterck,Olivier Christian Brigitte; Yonzan,Nis- hant. A New Distribution Sensitive Index for Measuring Welfare, Poverty, and Inequality (English). Policy Research working paper ; no. WPS 10470; RRR Washington, D.C. : World Bank Group. http://documents.worldbank.org/curated/en/099934305302318791/ IDU0325015fc0a4d6046420afe405cb6b6a87b0b 36 Closing gender disparities can support stronger poverty reduction in the region RETAINING THE GROWTH MOMENTUM Box 4.1: Gender Employment Gaps Index (GEGI)   The Gender Employment Gaps Index (GEGI) quantifies the potential economic benefits of equalizing employment rates between men and women in terms of the percentage increase in long-run GDP per capita (Pennings, 2022). The basic GEGI is defined as the gap between male and female employment, as a share of total employment:     Basic GEGI= (lM-lF)/ (lM+lF) *100   where (l) the employment-to-population ratio of 15–64 year olds by gender.  This quantification of disparities in employment between males and females can provide insights into the economic impacts of these gaps because, in simple neoclassical growth models, the increase in long-run GDP is proportional to the change in the number of workers as the capital-to-output ratio is constant in the long run. Thus, for example, moving from no female employment to achieving gender parity in employment by doubling the number of workers would lead roughly to a doubling of long-run GDP (see Pennings, 2022, for a detailed discussion).  In addition to the basic GEGI, it is also possible to compute a Full GEGI, which disaggregates total gender employment gaps into a “better employment” gender gap and an “other employment” gender gap, where “other employment” is defined as employment that is not “better employment”:  Full GEGI = Better Employment gender gap + (1- ) Other employment gender gap  The Full GEGI is defined as a weighted average of the “better employment” gender gap and the “other employment” gender gap. Following Pennings (2020), better employment is defined as non-agricultural employees plus employers, to capture employment categories where people may be better able to use human capital and skills to increase their productivity. The weights =hLbe/(hLbe+Loe), measure the relative contribution of better employment and other employment to GDP, where h=hf=hm is human capital per worker and Lbe and Loe are the number of workers in better employment and other employment respectively.  Figure 4.4, which plots the GEGI index for the WB6 countries, illustrates the implications of achieving gender equality in employment. Kosovo, for example, could boost its long- term GDP per capita by between 43 and 45 percent if it closed its gender employment gap. In contrast, Albania could see improvements in long-term GDP per capita of around 12 percent. This difference may be related to differences in female labor force participation between the two countries. In 2023, Albana and Kosovo had the lowest and highest female labor force participation rates in the WB6 countries, respectively, with Albania’s rate being three times higher than Kosovo’s 22 percent. Bosnia and Herzegovina could see improvements in long-term GPD per capita between 20 and 22 percent, while North Macedonia is estimated to gain between 12 and 14 percent by eliminating its gender Closing gender disparities can support stronger poverty reduction in the region 37 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 employment gaps. Although higher-income countries have lower potential gains from reducing employment gaps, all the countries in the region would benefit from improving labor market outcomes for women.  FIGURE 4.4. Gender Employment Gaps Index 0.50 Kos ovo 0.40 0.30 GEGI Bi H 0.20 North Ma cedonia Al ba nia Serbia Montenegro 0.10 0.00 12 14 16 18 20 22 24 26 28 Thousands GDP per capita, PPP (constant 2021 international $) GEGI basic (%) GEGI full (%) Note: The figure plot the Basic and Full GEGI against GDP per capita (constant 2021 international $). Data in the figure have been updated with the most recent data from ILOSTAT. Source: ILO series “Employment-to-population by sex and age (%) – Annual (age 15-64)”. GDP per capita retrieved from WDI. References  Pennings, S. 2020. “The Utilization-adjusted Human Capital Index (UHCI)” Policy Research Working Paper 9375. © Washington, DC: World Bank  Pennings, S. 2022. “A Gender Employment Gap Index (GEGI): A Simple Measure of the Economic Gains from Closing Gender Employment Gaps, with an Application to the Pacific Islands.” Policy Research Working Paper 9942. © Washington, DC: World Bank. 38 Closing gender disparities can support stronger poverty reduction in the region RETAINING THE GROWTH MOMENTUM 5. Maintaining fiscal prudence is needed to preserve past consolidation gains After three years of consolidation, the Despite the fading inflationary impetus, WB6 countries are set to experience public revenues continue to increase, albeit widening fiscal deficits during 2024. at a slower pace than in 2023. Nominally, Revenue performance remains robust across tax revenue growth for the first half of the year the region, but expenditures are increasing remains strong across all WB6 countries, ranging faster. The average21 fiscal deficit level for the from 7.2 percent in Albania and 8.6 percent in WB6 countries is expected to increase by Montenegro, to between 13 and 14 percent in 1 percentage point (pp) of GDP, reaching Kosovo, Serbia, and North Macedonia. Bosnia 2.5 percent of GDP (Figure 5.1). Serbia is and Herzegovina is also experiencing strong the only country in the WB6 expected to nominal indirect tax growth. This momentum is maintain the same level of deficit from the partially driven by compliance gains, including previous year, while Montenegro is expected from formalization, and strong domestic activity to experience the highest increase after closing , with minor benefits from tax policy changes 2023 with a fiscal surplus. North Macedonia from one year before. Increases in minimum is expected to continue running the highest wages are boosting direct taxation, except for level of deficit, almost double the regional Kosovo where minimum wage increases were average in 2024. Strong growth and inflation associated with a full tax exemption. Total coupled with the withdrawal of pandemic and revenues are also expected to increase as a share inflationary crisis measures led to a solid post- of GDP in four out of the six WB6 countries, pandemic consolidation until 2023; however, with North Macedonia and Albania expected to a wave of electoral cycles across the region, gain most by 2.4 and 1.4 pp of GDP in revenue, heavily impacted by the recent inflationary respectively. Nonetheless, growth in revenue episode, poses risks for hard-won gains in fiscal is slower than in 2023. On the other hand, consolidation. Montenegro is expected to see a drop in revenues FIGURE 5.1. FIGURE 5.2. Fiscal deficits are widening in 2024… …against broad based expenditure growth Fiscal balance, percent of GDP Contribution to change in the fiscal balance, percent of GDP, 2024e 2022 Expen diture 2023 Revenue 2024e Change in fiscal balance 1 6 5 0 4 -1 3 2 -2 -1.1 1 0 -1.7 -3 -2.2 -2.3 -2.5 -1 -2.8 -4 -2 -5 -3 -4 -4.9 -6 B iH A LB S RB KO S MN E MKD W B6 MKD SRB ALB BiH KOS MNE WB6 Sources: National statistical offices, ministries of finance and Sources: National statistical offices, ministries of finance and World Bank staff estimates. World Bank staff estimates. 21 From here on, the regional average refers to the regional unweighted arithmetic average. Maintaining fiscal prudence is needed to preserve past consolidation gains 39 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 as a share of GDP because of the significant following a significant rise in the minimum impact of one-off revenues in 2023. Kosovo will pension from January 2024. The long-term also see a slight drop because of the sizable impact sustainability of state pension systems in the of EU on-budget grants in 2023. In fact, one-off face of not only rising pressures for more EU budget grants averaged 0.5 percent of GDP spending, but also informality and aging in 2023 for all WB6 countries except Bosnia and populations, remains a significant challenge. Herzegovina, and tax revenue growth is expected On the other hand, except for Bosnia and to largely compensate for their absence in 2024. Herzegovina and Montenegro, spending on public wages has also continued to increase Increased public expenditures are driving as a share of GDP, albeit at a slower rate than the deficit expansion across the WB6 in 2023. North Macedonia is expected to countries in 2024 (Figure 5.2). Revenues as experience an increase of 0.9 pp of GDP in its share of GDP are projected to experience only wage bill, while Serbia and Albania are both a minor increase and deficits are mostly driven expected to see wage-bill increases of 0.6 pp of by expenditure growth. For the first part of GDP. Kosovo will see a slight increase of 0.2 the 2024, expenditures across the WB6 region pp of GDP in wage spending. experienced double-digit nominal growth. As a share of GDP, expenditures are expected to Most countries of the region are also increase by more than 2 pp of GDP in Albania, experiencing a rebound in capital spending. North Macedonia, and Montenegro, followed Capital spending will, on average, expand by an increase of 1.7 pp of GDP in Bosnia by 0.5 pp of GDP for the region, reaching and Herzegovina. Primary fiscal balances will a record level of 5.9 percent of GDP. Serbia, be negative in all WB6 countries except for the region’s largest country, is expected to end Albania where primary balance is expected to 2024 with capital investments amounting to be zero. . Interest expenditures remain sizable close to 8 percent of GDP, the highest level at about 2 percent of GDP for the WB6 recorded since 2006. With the exception of countries with access to international debt Bosnia and Herzegovina, public investments— markets. Kosovo and Bosnia and Herzegovina predominated by transport infrastructure represent an exception and have low levels of investment—will rise by about 1 pp of GDP interest payments due to lower debt shares in Serbia and Albania, and by 0.5 pp of GDP compared to the rest of the countries. or slightly lower in Montenegro, Kosovo, and North Macedonia. Bosnia and Herzegovina Increases in expenditure are broad-based, is expected to maintain the same—and the but spending on social benefits is leading the lowest—level of capital spending, at just 3.8 way (Figure 5.3). While the entire WB6 region percent of GDP. Despite the increase, capital is experiencing population aging, accelerated budget under-execution remains endemic by outmigration of younger cohorts, social for most WB6 countries. The EU Growth benefits spending—predominated in the form Plan, with a significant portion of financing of pensions—is expected to increase in every dedicated to projects under the Western WB6 country, with the WB6 average increasing Balkans Investment Framework, could further from 13.2 percent in 2023 to 14.1 percent of bolster medium-term public investment GDP in 2024. After Bosnia and Herzegovina, spending in the WB6 region, but addressing North Macedonia is also seeing high levels public investment management bottlenecks of social spending, with both countries requires immediate attention. expected to spend almost one-fifth of their GDP on social benefits in 2024 (Figure 5.4). Montenegro is set to experience the highest increase in social spending (1.7 pp of GDP) 40 Maintaining fiscal prudence is needed to preserve past consolidation gains RETAINING THE GROWTH MOMENTUM FIGURE 5.3. FIGURE 5.4. Capital spending has rebounded… …while all WB6 countries have turned to higher spending on social benefits Composition of estimated public spending, 2023 and 2024e, percent of GDP Contribution to change, 2024e, in percent of GDP Wa ge bil l Capital Expenditures Wa ge bil l Capital Expenditures 50 Socia l benefits Total expenditures 3 Socia l benefits Total expenditures 45 40 35 30 25 2 20 15 10 5 1 0 2024e 2024e 2024e 2024e 2024e 2024e 2024e 2023 2023 2023 2023 2023 2023 2023 0 SRB MNE BiH MKD KOS ALB WB6 SRB ALB MNE KOS BiH MKD WB6 Source: National statistical offices, ministries of finance and Source: National statistical offices, ministries of finance and World Bank staff estimates. World Bank estimates. After three years of consistent decline, public the only WB6 country in which PPG debt and publicly guaranteed (PPG) debt in the as a percentage of GDP has surpassed its pre- region is estimated to increase only slightly pandemic peak. In Albania, in line with the in 2024. For the first time since the pandemic, fiscal rule, the public debt ratio is estimated to PPG debt is expected to experience a minor decline by 1.5 pp—the largest decline in the increase as a share of GDP, from 46.8 percent region—driven by a mix of fiscal consolidation, in 2023 to 47.2 percent in 2024 (Figure 5.5). higher growth, and the appreciation of Montenegro and North Macedonia are driving the Albanian lek. Serbia is expected to see this regional increase, with PPG debt as a share a reduction of 0.4 pp in its PPG debt-to- of GDP rising by 2.8 and 1.5 percentage points GDP ratio. In Bosnia and Herzegovina, the in 2024, respectively. Montenegro’s increase is combination of a denominator effect, negative primarily due to the issuance of a Eurobond net borrowing, and slow project disbursement to cover 2024 financing needs and create a and implementation is estimated to cause buffer for 2025. North Macedonia’s increase is a 0.3-pp decrease in PPG debt as a share of driven by a persistently high fiscal deficit and GDP, while Kosovo’s PPG debt-to-GDP ratio the greater issuance of domestic securities for is estimated to remain at 17.4 percent, the liquidity purposes. North Macedonia is also lowest among the WB6 countries. FIGURE 5.5. FIGURE 5.6. Public and publicly guaranteed debt as a share …as has external public and publicly of GDP has declined to its lowest in a decade… guaranteed debt Public and publicly guaranteed debt, percent of GDP External public and publicly guaranteed debt, percent of GDP 90 2024e 80 2024e 80 2023 70 2023 pre-pandemic peak pre-pandemic peak 70 pre-pandemic low 60 60 50 50 40 40 30 30 20 20 10 10 0 0 MNE MKD SRB ALB BIH KOS WB6 MNE MKD ALB SRB BIH KOS WB6 Sources: National statistics offices; World Bank staff estimates. Sources: National statistics offices; World Bank staff estimates. Maintaining fiscal prudence is needed to preserve past consolidation gains 41 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 External PPG debt is estimated to grow more continued, though with a slight decline, as sharply than overall PPG debt. The external Montenegro issued a seven-year US$750 million PPG debt-to-GDP ratio for the WB6 countries is Eurobond at a 7.2522 percent coupon rate in March, projected to increase from 30.6 to 31.8 percent, with reflecting a modest reduction compared with all WB6 countries except Albania seeing an increase 2023 yield levels. Similarly, Serbia issued a 10-year in external PPG debt (Figure 5.6). Montenegro’s €1 billion Eurobond in June 2024 at a 6 percent external PPG debt is expected to remain the highest coupon rate. ​Even though they have decreased by among the WB6, reaching 58.8 percent of GDP in an average of around 60 basis points compared with 2024—an increase of 6.5 pp from 2023—due to six months ago, yields on the existing Eurobonds its large Eurobond issuance and planned borrowing of WB6 countries remain elevated (Table 5.1). from international financial institutions later in Notwithstanding this, the credit rating agencies the year to create fiscal buffers for 2025. Other have either confirmed or upgraded the ratings of all countries are estimated to see modest increases in WB6 countries (Table 5.2). The latest S&P ratings their external PPG debt-to-GDP ratios, ranging upgraded the outlook from stable to positive in from 0.4 pp in Bosnia and Herzegovina to 0.9 pp Serbia, signaling improving economic conditions in North Macedonia. Kosovo continues to have the and fiscal management, while Montenegro received lowest share of external PPG debt, at 7.8 percent a credit rating upgrade from B to B+, reflecting of GDP , further constrained by the requirement of financial resilience and economic growth. These a two-thirds parliamentary vote to authorize new upgrades highlight positive developments in the external debt. Serbia and Kosovo maintain active region despite global economic challenges. engagement with the IMF, which has conducted reviews and made available a total of €63 million Given that global interest rates remain for Kosovo, €200 million for North Macedonia, elevated and economic conditions continue and €400 million for Serbia, with the latter treated to be volatile, fiscal prudence is essential to as precautionary. prevent unsustainable debt levels. Establishing independent fiscal councils (e.g., in North The WB6 countries continue to face elevated Macedonia and Montenegro) or strengthening borrowing costs despite some improvement in existing ones (e.g., in Serbia) would play a critical global market conditions, driven by persistent role in ensuring fiscal discipline by providing economic uncertainties and rising interest rates. unbiased assessments of government budgets, After pausing their market activity in 2022, most enhancing transparency, and promoting long-term WB6 countries resumed accessing international economic stability (see Box 5.1). These institutions markets in 2023, albeit under significantly different can guide prudent decision-making, mitigate and more challenging conditions. This return came risks, and foster confidence among international amid a new landscape of higher interest rates and investors—factors that are crucial for the WB6 cautious investor sentiment, reflecting the ongoing region’s economic resilience. Also, the WB6 global economic uncertainties. In 2023, several countries should avoid increasing current spending, WB6 countries reentered the Eurobond market at particularly during election years, and focus on significantly higher costs, with Serbia issuing two optimizing public spending, especially in areas Eurobonds totaling US$1.75 billion at coupon such as public sector wages and social programs, rates of 6.25 and 6.5 percent, respectively, North to improve cost efficiency. Finally, aligning fiscal Macedonia issuing a €500 million bond at 6.96 legislation and statistics with EU methodologies percent, and Albania raising €600 million at 5.9 such as the European System of Accounts 2010 will percent, all reflecting a sharp rise in borrowing be vital for improving fiscal governance, meeting costs compared with previous years when coupon EU accession criteria, and enhancing the region’s rates were as low as 1 percent. In 2024, the trend overall economic stability and integration into the of elevated borrowing costs for WB6 countries broader European market. 22 In March 2024, Montenegro hedged its US$750 million Eurobond by converting it into euros through a cross-currency swap, reducing the effective interest rate to 5.88 percent. 42 Maintaining fiscal prudence is needed to preserve past consolidation gains RETAINING THE GROWTH MOMENTUM TABLE 5.1. Yields on WB6 countries outstanding Eurobonds   Coupon Maturity Yield in % Yield in % Yield in % Yield in % Spreads (28 Mar (26 Sep (5 Mar (18 Sep (basis 2023) 2023) 2024) 2024) points) Albania 3.5 16/06/2027 6.5 5.5 4.5 4.4 235.8 3.5 09/10/2025 6.1 5.5 4.4 4.3 119.9 Montenegro 2.785 16/12/2027 8.4 6.8 6.2 5.2 305.0 3.375 21/04/2025 7.3 5.9 5.1 4.3 105.6 North Macedonia 6.96 13/03/2027 - 6.0 5.2 5.1 296.1 2.75 18/01/2025 6.4 6.0 5.6 5.1 190.6 Serbia 3.125 15/05/2027 5.8 6.2 4.5 4.2 208.4 6.25 26/05/2028 - 6.8 5.9 5.3 310.3 Bosnia & 4.75 01/01/2026 7.0 7.1 7.9 6.6 341.9 Herzegovina, Republic of Srpska Source: Source: https://www.boerse-frankfurt.de/en, accessed on 11 September 2024 Note: Spreads refer to spreads with yields on German bonds with the same or similar residual maturity TABLE 5.2. Credit ratings of the WB6 countries Moody’s Standard & Poor’s Fitch Albania B1 (stable) BB- (stable) — Kosovo — — BB-(stable) BiH B3 (stable) B+ (stable) — Montenegro B1 (stable) B+ (stable) — North Macedonia — BB- (stable) BB+ (stable) Serbia Ba2 (positive) BB+ (positive) BB+ (stable) Maintaining fiscal prudence is needed to preserve past consolidation gains 43 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Box 5.1: Fiscal governance in the WB6 countries: Ensuring fiscal sustainability Debt sustainability is crucial for economic stability, particularly in economies where fiscal policy has been more volatile and the options for monetary policy are limited. In the WB6 countries, maintaining sustainable debt levels is essential in preserving fiscal space for fostering growth and green transition, as well as for the capacity to respond to future shocks. The WB6 region has been grappling with the aftermath of multiple crises, which have increased volatility, public debt, and borrowing costs. Public debt for the WB6 countries reached its peak of 60.2 percent of GDP in 2020, with the average deficit close to 8 percent of GDP, which triggered action by the authorities to bring debt levels down. Fiscal rules and fiscal councils have since emerged as crucial tools to address challenges related to fiscal sustainability, and the volatility of discretionary fiscal policy. These instruments are designed to strengthen fiscal frameworks, promote debt sustainability, and increase the credibility of fiscal policy. In the WB6 countries, where government spending has fluctuated between procyclical and countercyclical patterns, these rules and councils should help promote a more stable and less discretionary fiscal policy. As of summer 2024, all WB6 countries have introduced some form of fiscal rules, but only Serbia and North Macedonia have operational independent fiscal councils. The Serbian fiscal council has been in place for more than a decade, and is similar to the fiscal council in Bosnia and Herzegovina’s entity of Republika Srpska, covering about 30 percent of the country’s government finances. North Macedonia established a fiscal council in 2023, although the fiscal rules are only to be implemented from 2025. Montenegro has started setting up a fiscal council, though its members have not yet been appointed. Meanwhile, Albania has started considering establishing such a body. A public perception survey conducted by the World Bank in 2023 revealed that public finance sustainability is the top concern among stakeholders in the WB6 countries.23 Awareness of fiscal rules has improved since 2018, but only half of the respondents could correctly identify their country’s fiscal rules. The trust in compliance with these rules has increased, with more than half of the participants expressing confidence in adherence. Most respondents find the authorities’ reports on compliance with fiscal rules to be credible, and around two-thirds believe that they are effective. However, the survey also highlighted the need for greater transparency and the availability of public reports, with strong support for strengthening the independence of fiscal councils or establishing them where they do not yet exist. Analysis using the European Commission’s Fiscal Governance Compliance Methodology24 shows that fiscal rules and councils in the WB6 countries could be further strengthened to support fiscal policy credibility and better comply with the acquis directive on budgetary frameworks. The qualitative comparisons of fiscal rules, councils, and medium-term fiscal frameworks of the WB6 countries to those in Central, Eastern, and Southeastern European (CESEE) EU member states reveal that fiscal rules 23 The online questionnaire by country disseminated via social media and through email communication in November 2023 had 109 respondents. A similar survey was carried out in December 2018. 24 Available at: https://economy-finance.ec.europa.eu/economic-research-and-databases/economic-databases/fiscal-governance-data- base_en 44 Maintaining fiscal prudence is needed to preserve past consolidation gains RETAINING THE GROWTH MOMENTUM in the WB6 countries lack prudent fiscal accounting (due to cash accounting and off- budget spending that is not reported as part of the general government), strong monitoring systems for rule adherence, budgetary safety margins, automatic correction mechanisms, and proper economic cycle adjustments. While de jure WB6 fiscal councils are comparable in scope with those of CESEE, they underperform in actively promoting transparency, macroeconomic forecasting, and long-term sustainability assessments. Furthermore, they scarcely offer any normative recommendations on fiscal policy direction. In addition, WB6 medium-term budgetary frameworks score worse than those in CESEE. The primary shortcomings include weak links to annual budgets, the absence of correction mechanisms for discrepancies between the two, and the fact that the fiscal council does not prepare the macroeconomic and fiscal forecasts used in the medium-term plans but only reviews them. Overall, medium-term fiscal frameworks are merely indicative, can be easily altered, and fail to offer genuine guidance on fiscal policy behavior over the medium term. The current fiscal frameworks in the WB6 countries raise concerns about their adequacy in ensuring medium-term debt sustainability. Using deterministic and stochastic debt sustainability analysis, the assessment reveals that debt sustainability in the WB6 countries is at risk under scenarios such as unfavorable interest rate-growth differentials, lower structural primary balances, and financial stress. Only Serbia’s debt-to-GDP ratio is projected to decline under all three scenarios, albeit remaining at higher levels. Economic shocks pose the greatest risk to complying with fiscal rules. These findings underscore the need for more effective fiscal instruments to guide the WB6 countries toward a more resilient and sustainable economic path. The recent changes to the EU Fiscal Governance Framework, which entered into force in 2024, aim to strengthen debt sustainability and promote inclusive growth in member states. This highlights further the need for improved technical and analytical capabilities within the WB6 fiscal institutions in light of their EU accession ambitions. The WB6 economies generally have lower public debt levels and fiscal rules aligned with, or more stringent than, the EU’s benchmarks. Thus, regarding overall public debt and budget deficit levels, adaptation to the new EU fiscal rules should present no significant challenge for these economies. However, the WB6 countries may face challenges in meeting multi- annual budgetary objectives due to insufficient infrastructure for long-term planning and projections. In addition, the updated EU Fiscal Governance Framework could negatively impact public investment in the WB6 countries, given their extensive investment needs. To secure fiscal space for a green agenda, the WB6 countries might consider reforming their tax systems to increase progressivity and revenue collection, ensuring that they meet fiscal targets without compromising essential public investments. The WB6 countries should ideally have fiscal rules that do not restrict investment and growth to better accommodate economic convergence, accompanied by further institutional reforms. Strategic investment clauses and adherence to a ‘golden rule’ are current strategies to address investment needs. However, the efficacy of large investments hinges on improved institutional frameworks that guarantee competitive public procurement and transparency. Fiscal rules should also encourage counter-cyclical spending to manage macroeconomic imbalances, especially where monetary policy options are limited. Maintaining fiscal prudence is needed to preserve past consolidation gains 45 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 FIGURE 5.7. Note: The Fiscal Rule Strength Index measures the strength of fiscal rules based The Country Fiscal Rule Strength Index for the WB6 on the following variables: Statutory/ countries and the EU member states from CESEE legal base of the rule; room for setting or revising objectives; nature of the body in 25.0 charge of rule monitoring and the correction 20.0 mechanism; real-time monitoring; nature 15.0 of the body in charge of monitoring the 11.3 10.9 correction mechanism in case of deviation 10.0 10.4 10.1 7.1 5.4 from the rule; independent body providing/ 5.0 endorsing macro/budgetary forecasts; 0.0 correction mechanisms in case of deviation Bi H Latvi a Se rbi a P ol and C roati a Kos ovo Es toni a Al bani a Bul gari a Hungary Sl ovaki a Romani a Sl ove ni a Li thuani a Monte ne gro North Macedonia C z e ch Re publ i c from the rule; resilience to shocks or events outside the control of the government. The fiscal rule in North Macedonia will become operational only in 2025 and in Serbia it has been delayed until 2029. The other fiscal rules refer to 2022. FIGURE 5.8. Note: The Scope Index for Independent Scope Index for Independent Fiscal Institutions, in the Fiscal Institutions measures the breadth of tasks covered by independent fiscal WB6 countries and the EU member states from CESEE institutions based on the following variables: monitoring compliance with fiscal rules; 80.0 macroeconomic forecasting; budgetary 70.0 60.1 forecasting and policy costing; analysis of 60.0 52.6 52.6 50.0 48.9 long-run sustainability of public finances; 40.0 active promotion of fiscal transparency; 30.0 and normative recommendations on fiscal 20.0 policy. For Slovenia: * refers to the fiscal 10.0 council, whereas ** refers to the Institute of 0.0 Macroeconomic Analysis and Development. North Macedonia Cze ch Re public Ro m an ia Slo ve n ia* Se rbi a Bu lg ar ia L it h u an ia L at via Hu n g ar y Monte ne g ro Es t o n ia Slo vak ia BiH C r o at ia Slo ve n ia** Po lan d Fiscal councils in Montenegro and North Macedonia will become operational only in 2024. Other fiscal institutions refer to 2022. The fiscal council in BiH covers only Repub- lika Srpska. Albania and Kosovo do not have fiscal councils. FIGURE 5.9. Note: The MTBF index measures the quality Medium-term budgetary framework index, in the WB6 of medium-term budgetary frameworks (MTBF) along five dimensions: coverage of countries and the EU member states from CESEE the targets/ceilings included in the national medium-term fiscal plans; connectedness 1.0 between targets/ceilings included in the 0.9 national medium-term fiscal plans and the 0.8 annual budgets; involvement of national 0.7 parliament or use of coalition agreement in 0.6 0.6 0.5 0.5 the preparations of national medium-term 0.5 0.4 0.4 0.4 0.4 0.4 0.4 plans; involvement of independent fiscal 0.4 institutions in the preparation of national 0.3 medium-term fiscal plans; and the level of 0.2 detail included in the national medium-term 0.1 fiscal plans. For BiH: * refers to the MTBF 0.0 that refers to the whole of Bosnia and North Macedonia** North Mac edonia* Latv ia Slov enia Romania Slov akia Lithuania Bulgar ia Cr oatia Es tonia Ser bia Cz ec h Republic Hungar y Montenegr o A lbania BIH*** Poland Kos ov o BiH** BiH* Herzegovina, ** to the MTBF that refers to Federation BiH, and *** to the MTBF for Republika Srpska. For North Macedonia: * refers to the existing MTBF in North Macedonia, ** to the new MTBF, that will enter into force in 2025. Other MTBF’s rules refer to 2022. Source: DC-ECFIN for EU member states, World Bank staff calculations for WB6. World Bank and The Vienna Institute of International Economic Studies 46 Maintaining fiscal prudence is needed to preserve past consolidation gains RETAINING THE GROWTH MOMENTUM 6. Inflation is continuing to decelerate, but at a slower pace During 2024, global inflation has continued to disparities between advanced economies and decline, although it remains above target in EMDEs, with median headline inflation rates many countries worldwide. Recent data suggest reaching 2.5 and 4.0 percent, respectively, by that the pace of the decline in inflation has slowed, July. indicating that post-pandemic disinflationary pressures—previously underpinned by declining The momentum of disinflation is slowing, commodity prices and the normalization of reflecting different country and sectoral supply chains—are finally easing. Key drivers of dynamics. In major advanced economies, the slowdown in the pace of consumer price including in the Euro area, disinflation disinflation include a partial rebound in energy in consumer goods prices appears to have prices, together with a notable deceleration in the bottomed out, while inflation in consumer rate of decline in core inflation25 (Figure 6.1). services prices remains more elevated (Figure During the first months of 2024, inflation 6.2). Wage growth remains robust in many declined more prominently in advanced countries worldwide. Aggregate commodity economies than in EMDEs), where on average prices have partially rebounded in the first price pressures remained more elevated. As of July months of 2024 after declining, on average, in 2024, the global median headline inflation rate 2023, partly reflecting heightened geopolitical stood at 3 percent, down from its peak of 9.4 tensions. The World Bank commodity price percent two years earlier. There are, however, index was 4.1 percent higher in July 2024 than in the previous year. FIGURE 6.1. FIGURE 6.2. The pace of decline in core inflation has In the Euro area service inflation remains slowed this year elevated Median global core inflation (percent, yoy) Goods and services inflation (yoy, percent) 9 Global 18 Euro area services 8 Advanced 15 Euro area goods 7 economies EMDEs 12 6 5 9 4 6 3 3 2 0 1 0 -3 Jul-21 Jul-19 Jul-22 Jul-23 Jul-20 Jan-21 Apr-21 Oct-21 Oct-19 Jan-22 Apr-22 Jan-23 Apr-23 Jan-24 Apr-24 Jan-20 Apr-20 Oct-22 Oct-23 Oct-20 Jun-19 Oct-19 Feb-20 Jun-20 Oct-20 Feb-21 Jun-21 Oct-21 Feb-22 Jun-22 Oct-22 Feb-23 Jun-23 Oct-23 Feb-24 Jun-24 Source: World Bank Global Economic Prospects. Source: Eurostat; World Bank Global Economic Prospects. 25 Core inflation focuses on the underlying and persistent trends in inflation by excluding transitory price changes such as prices that are more volatile, including food and energy, most affected by seasonal factors or temporary supply conditions. Inflation is continuing to decelerate, but at a slower pace 47 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 FIGURE 6.3. FIGURE 6.4. Inflation heterogeneity among countries WB6 core inflation remains high persists Core inflation, in percent WB6 CPI inflation, in percent 24 ALB 15 WB6 core KOS EU27 headline MNE 13 WB6 healdine 19 WB6 11 BIH 14 MKD 9 SRB 7 9 5 4 3 1 -1 -1 Dec-20 Dec-22 Dec-23 Aug-22 Aug-23 Oct-22 Oct-23 Feb-22 Apr-22 Jun-22 Feb-23 Apr-23 Jun-23 Feb-24 Apr-24 Jun-24 Dec-21 Aug-21 Oct-21 Feb-21 Apr-21 Jun-21 Oct-20 Oct-22 Oct-23 Jan-20 Apr-20 Jan-22 Apr-22 Jan-23 Apr-23 Jan-24 Apr-24 Oct-21 Jul-20 Jan-21 Apr-21 Jul-22 Jul-23 Jul-24 Jul-21 Source: Statistical offices and World Bank staff calculations. Source: Statistical offices and World Bank staff calculations. In line with international trends, in 2024 Core inflation continues to outpace WB6 countries have experienced a reduction headline inflation, underscoring the impact in inflation, though the pace of this decrease of price pressures from domestic factors. has been more gradual than in the preceding Although core inflation declined from 5.0 to year (Figure 6.3). At the regional level, 4.4 percent between January and July (Figure consumer price inflation eased from 4.4 6.4), it remains high in several countries in percent at the outset of the year to 3.2 percent the region. As of July 2024, North Macedonia by July. By July 2024, Serbia and Montenegro recorded the highest core inflation rate at 5.7 recorded the highest headline inflation rates, at percent, followed by Serbia (5.1 percent) and 4.3 and 3.5 percent, respectively, above the Montenegro (5 percent). These data indicate regional average. Conversely, North Macedonia that domestic price pressures remain strong, (3 percent), Kosovo (2.2 percent), Albania and inflation remains persistent. Pressures (2.0 percent), and Bosnia and Herzegovina arising from wage and production costs (1.8 percent) reported inflation rates below the are high. Moving forward, monitoring and regional mean (Figure 6.3). The continued containing excessive wage growth and ensuring downward inflationary trend is partially that it moves in line with productivity will attributable to the normalization of be central to managing inflation pressures international commodity prices. Given that and expectations. In previous years, rising food prices account for a large share of the minimum wages and tight labor markets led to consumption basket in WB6 countries, the rapid wage increases, which then spilled over deceleration in food prices has been a key into economy-wide wage increases. To avoid factor in the overall decline of inflation rates. the risk of further inflation persistency and Recent extreme weather events, however, may tame inflation expectations it will be important lead to renewed pressure on food prices during for policy makers to contain excessive wage the remainder of 2024. Energy prices have also growth and ensure that revisions to minimum decreased, mirroring the general trend of and public sector wages is informed by headline inflation, albeit exhibiting greater adequate analysis of the labor markets. volatility during the first half of 2024. 48 Inflation is continuing to decelerate, but at a slower pace RETAINING THE GROWTH MOMENTUM Declining inflation rates led central banks its policy rate by 25 basis points to the level of in countries with independent monetary 6.05 percent, noting that the latest conditions policies to embark on gradual monetary in the economy enable the start of gradual policy easing (Figure 6.5). In September, the prudent normalization of the monetary policy. National Bank of Serbia observed that yoy Moving forward, central banks will need to inflation has been hovering within the target carefully calibrate their monetary policy tolerance band (3 ± 1.5 percent) since May, actions to take into account evolving price with forecasts suggesting a steady convergence dynamics and risks to the financial sector. The to the target midpoint. As a result, it decided central banks of Serbia and North Macedonia to reduce the policy rate by 25 basis points in have (de facto) continued to stabilize their both July and September. Likewise, in July the exchange rates, while the Bank of Albania has Bank of Albania, recognizing that price opted for greater flexibility. The appreciation pressures were easing, reduced its policy rate of the Albanian lek against the US dollar in by 25 basis points to the level of 3 percent. 2024 has persisted, albeit at a slower pace Meanwhile, in early September the National (Figure 6.6). Bank of North Macedonia decided to reduce FIGURE 6.5. FIGURE 6.6. Central banks have cautiously initiated an …continuing to allow for different degrees of easing of monetary policy… exchange rate flexibility Policy rates, in percent Exchange rate changes, in percent 7 ALB 2 MKD 6 SRB 0 Eurozone 5 -2 4 -4 3 -6 2 -8 ALB MKD 1 -10 SRB 0 -12 Dec-20 Mar-20 Dec-22 Dec-23 Mar-22 Mar-23 Mar-24 Sep-20 Sep-22 Sep-23 Jun-20 Jun-22 Jun-23 Dec-19 Jun-24 Dec-21 Mar-21 Sep-19 Sep-21 Jun-19 Jun-21 Mar-17 Sep-17 Mar-18 Sep-18 Mar-19 Sep-19 Mar-20 Sep-20 Mar-21 Sep-21 Mar-22 Sep-22 Mar-23 Sep-23 Mar-24 Sep-24 Source: National central banks and World Bank staff calcula- Source: National central banks and World Bank staff calcula- tions. tions Inflation is continuing to decelerate, but at a slower pace 49 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 7. Financial stability remains resilient amid uncertainty, helping to support credit growth The financial system across the WB6 in business activity and an easing of credit countries have remained stable and resilient, conditions, and Montenegro.. Kosovo despite a weak external environment. During continued to post the highest level of loan 2023 and up to March 2024, asset quality was growth among the WB6 countries (13.6 mostly stable, with the exception of Albania, percent as of July 2024). and Bosnia and Herzegovina, where non- performing loans (NPLs) continued a slow Corporate credit growth accelerated, downward trend; average NPLs represented narrowing the gap with household loan 3.7 percent of total loans as of March 2024. growth recorded in 2023. The average While capital buffers strengthened during corporate loan growth increased steadily back 2023, by March 2024 they were at the same toward 2022 levels, rising from an average of comfortable levels as in December 2023, 4.3 percent in 2023 to 5.6 percent between with an average capital adequacy ratio of 19.1 January and June 2024 (Figure 7.2). By June, percent. corporate credit growth in WB6 reached 7.9 percent. Albania, followed by Kosovo, Bosnia After slowing in 2023, credit growth and Herzegovina and Montenegro, led the regained momentum in the first half of 2024 acceleration. Household loan growth, which (Figure 7.1). Average credit growth steadily suffered a less pronounced deceleration, increased in H1 2024, following the also recovered, rising to 9.7 percent between deceleration observed in 2023, with growth January and June 2024, and reaching 10.9 reaching 9.4 percent in June 2024 (from 6.5 percent by June 2024, led in most cases by real percent in December 2023). In particular, estate exposures. credit growth increased in Albania (13 percent as of July 2024),26 driven by an overall pick-up FIGURE 7.1. FIGURE 7.2. Credit growth rebounded in H1 2024 Corporate credit growth resumed its pace narrowing the gap with household growth Change in nonfinancial private sector credit outstanding, percent, yoy Change in credit outstanding June 2024, percent, yoy ALB MNE Firms Households BIH SRB 20 MKD KOS 25 15 20 10 15 5 10 0 5 -5 Jul-17 Jul-21 Jul-18 Jul-19 Jul-16 Jul-22 Jul-23 Apr-17 Jan-17 Jul-20 Apr-21 Oct-17 Apr-18 Jan-21 Apr-19 Apr-16 Jan-18 Jan-19 Jan-16 Oct-21 Oct-18 Oct-19 Oct-16 Apr-22 Apr-23 Apr-24 Jan-22 Jan-23 Jan-24 Apr-20 Jan-20 Oct-22 Oct-23 Oct-20 0 ALB BIH KOS MKD MNE SRB WB6 Sources: IMF International Financial Statistics; central banks. Source: Central banks. 26 Credit growth rates were affected by the appreciation of the Albanian lek that occurred during 2023. 50 Financial stability remains resilient amid uncertainty, helping to support credit growth RETAINING THE GROWTH MOMENTUM The credit supply and demand gap in WB6 With only marginal increments during early countries, persistent over the past couple of 2024, NPLs reached 3.7 percent of total loans years, is diminishing with the tightening in by March 2024 (Figure 7.3). Asset quality credit supply expected to gradually ease. improvements mostly stabilized in 2024, after According to the results of the latest Central, decelerating in 2023, particularly in jurisdictions Eastern and Southeastern Europe (CESEE) with limited credit growth (on average, NPLs Bank Lending Survey,27 between September decreased by 0.2 pp between December 2022 and 2023 and March 2024, credit supply improved 2023). Albeit at higher levels than the pre-global slightly, albeit remaining tight, while credit financial crisis period, NPLs have decreased demand remained resilient, driven by significantly over the years, with Albania, and inventories, working capital, and also Bosnia and Herzegovina at the lowest level consumer credit. Going forward, the recorded since 2011 (4.6 and 3.6 percent, tightening of credit supply, triggered by the respectively, as of March 2024). When looking macroeconomic and financial environment, at comparisons with the WB6 average by March, appears to be ending, boosted by a more NPLs remain higher than the regional average in benign outlook, while demand is expected to Albania and Montenegro as of March 2024 (4.6 remain positive. Fixed investments, inventory and 5.8 percent, respectively). Moreover, while and working capital on the corporate side, as the volume of stage 228 loans slightly declined in well as real estate and consumer credit, are the region (CEE), it is still higher than the pre- expected to drive credit demand. Overall, pandemic levels, and a sizable gap between stage foreign banks operating in the WB6 region see 2 and stage 3 volume of loans is still present, the the market potential as mostly strong, although slight downward trend notwithstanding.29 The exposures are not expected to expand over the CESEE Bank Lending Survey also indicates that next six months. banks expect NPLs to remain stable throughout the remaining of 2024.30 FIGURE 7.3. FIGURE 7.4. Asset quality showed limited movement Capital levels remained relatively stable NPLs as a percentage of total loans Capital adequacy ratios 7 Jun-23 25 Jun-23 Sep-23 Sep-23 6 Dec-23 Dec-23 Mar-24 20 Mar-24 5 4 15 3 10 2 5 1 0 0 MNE ALB BiH SRB MKD KOS WB6 SRB MNE ALB BiH MKD KOS WB6 Sources: IMF Financial Soundness Indicators; central banks. Sources: IMF Financial Soundness Indicators; central banks. 27 EIB Central, Eastern and Southeastern Europe Bank Lending Survey, H12024. 28 Stage 2 assets, in the context of International Financial Reporting Standard (IFRS 9), are financial instruments that have deteriorated significantly in credit quality since initial recognition but that offer no objective evidence of a credit loss event. Assets are classified stage 3 if the loan’s credit risk increases to the point where it is considered credit impaired. The IFRS is published by the International Accounting Standards Board. IFRS 9 specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy and sell nonfinancial items. 29 NPL Monitor H1 2024. 30 EIB Central, Eastern and Southeastern Europe (CESEE) Bank Lending Survey, H1 2024. Financial stability remains resilient amid uncertainty, helping to support credit growth 51 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Capital adequacy remained at comfortable and risks, including through stress testing. levels in the WB6 countries supported Moreover, authorities should remain alert to by sustained profitability, while liquidity potential deteriorations in asset quality. In view remained broadly stable. As of March 2024, of this, the effective use of macroprudential the regional banks’ capital adequacy ratio tools, including countercyclical capital buffers, averaged 19.1 percent, far above the regulatory loan-to-value and debt-to-income ratios, can minimum. Average capital levels have been help mitigate the impact of economic shocks relatively stable since June 2023 (19.1 percent) and downturns. and are mostly comprised of Tier 1 capital. At 16 percent as of March 2024, Kosovo holds Financial stability will be critical to ensure the lowest capital levels in the region, although sustainable growth in the WB6. Several still well above the regulatory minimum of countries have embarked on reforms to 9 percent. The ratio of liquid assets to total harmonize their frameworks and legislations assets averaged 26.8 percent in March 2024, with EU standards, including in the area of with the lowest liquidity ratio seen in North digital payments and transactions. A more Macedonia (18.4 percent) and the highest in digitalized and modern payment system Serbia (41.7 percent). could play a key role in supporting financial inclusion, trade and business activity more High interest rates continued to boost broadly. Moreover, it could play a critical banks’ lending margins and profitability. role in reducing informal transaction and Profitability, as measured by return on facilitating remittances flow (see Box 7.1). assets, has remained above 2 percent since March 2023 (2.5 percent as of March 2024), supported by the still high interest rates, which can boost net interest margins. Recent downward movements in lending rates may put some pressure on interest margins. As of March 2024, Serbian banks presented the highest profitability (3.1 percent) in the region, followed by Montenegro at 2.6 percent. Albania, despite a steady increase since September 2022, continued to have the lowest return on assets (2.2 percent as of March 2024). While financial systems remain resilient, continuous surveillance is required. With current economic growth expectations, still high interest rates, and a positive credit growth trend, overall, banks’ balance sheets are not expected to suffer significant additional pressures over the next few months. This situation notwithstanding, the persistent geopolitical tensions, and sluggish growth and labor markets in the EU, coupled with the pressures of high interest rates faced by borrowers, underscore the need for continuous monitoring of financial vulnerabilities 52 Financial stability remains resilient amid uncertainty, helping to support credit growth RETAINING THE GROWTH MOMENTUM Box 7.1: Migration and digitalization: How payment systems act as a lever For the WB6 countries, aspiring to intertwine more closely with each other and with the EU, reducing the cost of cross-border payment services is crucial for economic development. One key aspect of such integration is the membership of the WB6 countries in the Single European Payments Area (SEPA). SEPA is an initiative that facilitates bank transfers denominated in euro by treating all euro payments within its geographic scope equally, regardless of whether they are domestic or cross-border. Digital payments can reduce the informal economy by making transactions traceable and transparent, aiding tax collection, and reducing corruption and crime. Digitalizing payments can help provide access to financial services for underserved populations, and close gender and urban-rural gaps. In the WB6 countries, digital payments could help to provide financial access to an additional 1.9 million people.31 FIGURE 7.5. Average cost of sending US$200 in remittances to WB6 countries (Q2, 2024) - percent 10.00 Average Cost (%) 9.00 8.39 8.64 8.54 8.01 8.00 7.45 7.00 6.09 6.00 5.00 4.00 3.00 2.00 1.00 - Albania Bosnia and Kosovo Montenegro North Serbia Herzegovina Macedonia Source: World Bank staff calculations. Modern systems facilitate remittances, offering low-cost solutions for migrants to send money home, potentially saving the WB6 countries about €500 million in remittance costs annually. According to data on remittances collected by the World Bank, the average cost of sending remittances to WB6 countries is 7.9 percent of the transaction value, ranging from 6.1 percent in Kosovo to 8.6 percent in Bosnia and Herzegovina. This is more than twice the SDG target of 3 percent,32 despite being on average 7 percent cheaper than non- digital services. SEPA membership can bring significant reduction in costs of cross-border transfers. Currently, based on the costs and number of transfers observed with the EU, the WB6 countries could see between a 9- and 15-fold decrease in fees when receiving a €200 transfer. 31 World Bank staff calculations based on the World Bank Global Findex 2021 data. 32 The STG target is to reduce to less than 3 percent the transaction costs of migrant remittances and eliminate remittance corridors with costs higher than 5 percent. Financial stability remains resilient amid uncertainty, helping to support credit growth 53 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Modernizing payment systems is also critical to lowering business-to-business cross- border transfer costs. Digital payments can reduce transaction fees for businesses, making them more competitive and simplifying reconciliation processes and cashflow management. The World Bank has been monitoring business-to-business cross-border transfer costs in euros for micro, small and medium enterprises (MSMEs) in the WB6 countries and in selected EU countries to set benchmarks and inform program actions. The data collected so far reveal significant cost disparities between WB6 countries and the EU. For €5,000 transfers, costs within the WB6 are, on average, 10 times higher than within the EU, while for €20,000 transfers they are 17 times higher. Transfers from the EU to the WB6 are also more expensive, costing about 12 times more for €5,000 transfers and 15 times more for €20,000 transfers compared with intra-EU transfers. Similarly, sending €5,000 from the WB6 to the EU costs 10 times more than within the EU, and sending €20,000 costs 17 times more. After joining SEPA, based on the costs observed currently within the EU, WB6 firms could see between an 8- and 15-fold decrease in fees when sending a €5,000 transfer. Thus far, the WB6 countries have made significant progress by adopting EU-consistent legislation and developing retail payment infrastructures to enhance cross-border payments and become part of the SEPA. To become eligible for SEPA membership, the WB6 countries have been working to ensure that their payment systems, and laws and regulations governing payment services, banking, anti-money laundering and counter- terrorism financing (AML/CFT), are compliant with the EU legislation. This also involves ensuring that there are no legal, competition, tax, regulatory or other significant obstacles or impediments to ensuring an appropriate level playing field for all payment service providers in the SEPA area. Albania, Montenegro, and North Macedonia have already finalized the transposition efforts and have thus submitted their formal applications for SEPA membership (extension of the geographical scope) with the rest of the countries in the region soon to follow suit. Serbia and Kosovo are expected to submit their applications soon, while Bosnia and Herzegovina is still working on the necessary legal framework. Once the WB6 countries have been accepted into SEPA, individual payment service providers can apply to join the individual European Payments Council payment schemes and start processing SEPA payments. Alignment with these requirements, paired with the modernization of infrastructure, will facilitate the participation of WB6 countries in SEPA, thus improving market access and fostering economic integration within the WB6 region and with the EU. 54 Financial stability remains resilient amid uncertainty, helping to support credit growth RETAINING THE GROWTH MOMENTUM 8. The external deficit has been widening amid continued external pressures Western Balkan countries are navigating account for the deterioration of the external increasing pressures on their external sectors position. In Serbia, this development is being amid a challenging external environment. driven by a pick-up in private consumption The widening regional CAD is partly driven due to real wage growth, tightening labor by sluggish growth in the EU, particularly in markets, and credit growth, which caused Germany, a key trading partner. Therefore, stronger import growth and a decline in weakened foreign demand for exports, merchandise exports (in GDP terms) due to coupled with elevated energy costs and weaker foreign demand. In both countries, sluggish labor markets in the EU impacting however, the correction in the external account remittance inflows, has led to a deterioration represents a partial reversal, as it comes on the in the WB6 current account. Moreover, global back of an impressive narrowing of the current uncertainties, such as continued geopolitical account in 2023. tensions, keep risks elevated. Although oil prices have moderated slightly compared with Across most WB6 countries, both their peak in 2023 due to weaker demand merchandise exports and imports are from China, they remain high, keeping import expected to exhibit a downward adjustment costs elevated and maintaining pressure on the in GDP terms. As a result, the WB6 external accounts. Nevertheless, at the regional merchandise trade deficit is expected to level, 95 percent of these deficits are financed narrow at the margin, by 0.3 percentage through net FDI inflows, and most countries points compared with 2023, to 26.5 percent in the region experienced an increase in of GDP in 2024 (Figure 8.3). With the region foreign exchange reserves in the period June– witnessing a difficult landscape considering July 2024. that EU growth is expected to remain below 1  percent in 2024, this has led to weaker Following an improvement in 2023, the exports (in GDP terms) and a simultaneous external position of the WB6 countries decline in the region’s demand for imports deteriorated in 2024. This correction of intermediate inputs. The import of occurred after a significant narrowing of consumption goods, however, remains robust the CAD in 2023 by 3.6  percentage points due to private consumption contributing most compared to the year before.33 Specifically, to real GDP growth in most WB6 countries. the CAD is expected to deteriorate from 4.1 percent of GDP in 2023 to an estimated In 2024, the sharp rise in net services export 5.6 percent in 2024, which is still significantly inflows seen since 2021 is expected to come below the average over the past five years to an end. These inflows represent (Figure 8.1). Four countries—Albania, North predominantly net tourism inflows and Macedonia, Serbia, and Montenegro—are diaspora travel home, although signs of projected to experience a more pronounced diversification are also taking place, particularly current account widening in 2024, on the into Information Technology (IT) services. order of 3.0, 2.5, 1.5 and 1.2  percent of Overall, WB6 countries appear to have reached GDP, respectively (Figure 8.2). In Albania, a ceiling of between 11.5 and 12.5 percent of net services exports (in GDP terms) rather GDP over the past three years, which represents than movements in the merchandise balance more than a doubling of net service exports 33 These are simple averages across the six countries. The external deficit has been widening amid continued external pressures 55 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 compared with roughly 15 years ago. Specifically, Similar to net services exports, remittances net services exports are set to stabilize in 2024 at are also expected to stagnate in 2024, in GDP 11.6 percent of GDP compared to 11.5 percent terms. This may be the result of some signs of of GDP in 2022 (Figure 8.4). In Albania, reverse migration combined with a softening of Montenegro, and Kosovo, which have the highest labor markets across the Euro area. As a result, double-digit net services exports in GDP terms, almost all WB6 countries are set to experience a there have been sizable gains in tourism inflows mild deterioration in remittances from a peak of and diaspora travel home since the pandemic, close to 7 percent of GDP in 2022 to 6.1 percent overshooting peaks from pre-pandemic years. All in 2024. The largest decline in remittances, three countries show signs of stabilization at amounting to 0.6 and 0.3 percentage points, around 24 percent of GDP in Montenegro, 16 is expected in Kosovo and Serbia, respectively. percent in Kosovo, and 11-12 percent in Albania. In Kosovo, smaller scale sources of primary At the same time, services exports are experiencing income—from temporary workers abroad— a diversification, with IT and other business increased significantly, reflecting the impact of services gaining more prominence in countries visa liberalization that started in 2024. such as Kosovo, North Macedonia, and Serbia. FIGURE 8.1. FIGURE 8.2. The regional current account deficit has …with Albania, North Macedonia and Serbia been widening in 2024… accounting for the bulk of the external adjustment in 2024 Percentage of GDP Percentage of GDP M NE KO S BiH ALB SRB M KD WB6 Goods exports Goods imports 5 Net services exports Remittances Others Change in Current Account 0 8 -5 -10 4 -15 -20 -25 2007 0 2009 -30 2020 -35 2023 -4 -40 2024 BiH MNE ALB KOS SRB MKD Source: Regional central banks, World Bank staff calculations FIGURE 8.3. FIGURE 8.4. The merchandise trade deficit has returned …while remittances and net services to the five-year average seen prior to the exports have stagnated pandemic, after the deterioration in 2022… Percentage of GDP Percentage of GDP 40 20 Net services exports 38 Merchandise trade deficit 18 Remittances 36 16 34 14 32 12 30 10 28 8 26 6 24 4 22 2 20 0 2023e 2020 2022 2010 2013 2015 2016 2012 2018 2019 2021 2011 2014 2017 2024f 2023e 2008 2009 2020 2022 2010 2012 2013 2015 2016 2018 2019 2021 2011 2007 2014 2017 2024f Source: Regional central banks, World Bank staff calculations. 56 The external deficit has been widening amid continued external pressures RETAINING THE GROWTH MOMENTUM At the regional level the CAD is projected to of GDP in 2024, from a surplus of 0.6 percent be 95 percent financed by net FDI inflows in of GDP, and as refinancing shifts to external 2024 (Figure 8.5). Net FDI inflows are sources. In Kosovo, higher external public projected to total 5.3 percent of GDP in 2024, debt is projected to increase by 0.6 percentage falling short of the external deficit by 0.3 point to 7.8 percent of GDP to finance the percent of GDP. However, this masks more higher fiscal deficit. In North Macedonia, heterogeneous developments at the country meanwhile, higher private external debt level. In countries such as Albania, Bosnia and accounts predominantly for the rise in total Herzegovina, North Macedonia, and Serbia external debt. In Bosnia and Herzegovina, net FDI inflows fully finance, and in some Montenegro, and Serbia expected higher cases exceed, the external deficit. In other external public and publicly guaranteed debt countries, such as Kosovo and Montenegro, levels in 2024 are projected to be offset by a FDI is only expected to finance between 65 decline in private external debt. and 69 percent of their external deficits in 2024. These inflows are predominantly in the Most countries in the region have been form of equity investments and reinvestments, witnessing a build-up in foreign exchange with a smaller proportion in inter-company reserves over 2024. In Serbia, foreign loans (Figure 8.5). exchange (FX) reserves reached 7.2 months of imports of goods and services by Q2 of Total external debt appears to have 2024. Other countries experiencing a rise continued to decline in 2024 to around in foreign exchange reserves include Bosnia 70.2  percent of GDP. This outcome is the and Herzegovina, Kosovo and Montenegro. result of smaller total external debt in Albania, Meanwhile, Albania and North Macedonia saw Bosnia and Herzegovina, and Serbia, while falling foreign exchange reserves. Nevertheless, Kosovo and North Macedonia are expected to in Albania FX reserves still totaled 5.6 see a rise in total external debt. In Montenegro, months of imports in May 2024, whereas in external public debt (Figure 8.6) is likely to North Macedonia FX reserves amounted to rise by 6.5 percentage points in 2024 to close 4.3 months of imports, with both countries to 59 percent of GDP as the fiscal balance is exceeding the standard metric of 3 months of expected to shift to a deficit of around 3 percent imports. FIGURE 8.5. FIGURE 8.6. At the regional level, FDI inflows almost fully …with the regional PPG external debt level finance the current account deficit in 2024, projected to remain largely unchanged in although country differences are significant… 2024 Current account deficit and net FDI, Percentage of GDP PPG external debt, Percentage of GDP 14 CAD 2024 60 net FDI 2024 12 50 10 40 8 30 6 20 4 10 2 0 0 ALB BIH KOS MKD MNE SRB WB6 ALB BIH KOS MKD MNE SRB WB6 Source: Source: Regional central banks, World Bank staff calculations. The external deficit has been widening amid continued external pressures 57 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 9. The growth outlook: diverging growth drivers Following a slow start in 2024, gradual pp. This revision is driven primarily by an growth recovery in the euro area is projected increase in projected growth for Serbia (+0.3 to continue through 2025-2026, supporting pp), Bosnia and Herzegovina (+0.2 pp), economic activity in the WB6 region. Euro and Kosovo (+0.1 pp). On the other hand, area growth expanded by 0.6 percent year-over- there was a significant decrease in expected year in the second quarter, up from 0.5 percent growth in North Macedonia in 2024 (-0.7 in the first quarter, driven by exports and, to pp compared with Spring RER projections). a lesser extent, consumption expenditures. Similarly, in 2025, growth is expected to be While manufacturing PMIs have remained in 0.2 pp higher compared with previous Spring contractionary territory for two consecutive RER projections, driven by an improved years, services PMIs have consistently stayed outlook for Montenegro and Serbia. Bosnia above 50 since February 2024. The European and Herzegovina, and North Macedonia will Central Bank cut the deposit interest rate for have somewhat lower growth in 2025 than the second time this year by 25 basis points previously projected (Table 9.1). to 3.5 percent, as inflation eased to 2.2 percent in August. Growth in the euro area is There is also a change in the drivers of anticipated to gradually strengthen in 2025- growth. Investment and exports of goods 2026, driven by increasing momentum in and services will make a more significant export and investment activities, supported by contribution to growth in 2024, while in outer more accommodative monetary policy and the years (2025–26) consumption will contribute effective deployment of EU funds. more to WB6 growth than was previously projected. Part of this higher consumption Growth in the WB6 region is expected (and, to a lesser extent, investment) is expected to increase slightly over the projection to be reflected in higher imports. Therefore, period. Compared with the Spring RER the negative contribution to growth from projections, in 2024, the expected increase imports will be higher by 1.2 pp and 0.3 pp in growth for the WB6 region will be 0.1 in 2024 and 2025, respectively (Figure 9.1). TABLE 9.1. Real GDP growth in WB6 countries, percent   2024  2025 2026   Spring Autumn Spring Autumn Spring Autumn edition edition edition edition edition edition Albania 3.3 3.3 3.4 3.4 3.5 3.4 Bosnia and Herzegovina 2.6 2.8 3.3 3.2 4.0 3.9 Kosovo 3.7 3.8 3.9 3.9 3.9 4.0 North Macedonia 2.5 1.8 2.9 2.5 3.0 3.0 Montenegro 3.4 3.4 2.8 3.5 3.0 3.2 Serbia 3.5 3.8 3.8 4.2 4.0 4.0 WB6 3.2 3.3 3.5 3.7 3.8 3.7 Source: World Bank staff estimates. 58 The growth outlook: diverging growth drivers RETAINING THE GROWTH MOMENTUM Within the WB6 region there is also a more promote private sector growth (such as through pronounced division between countries where the payments initiative related to the Single faster recovery of consumption and investment Euro Payment Area). Second, growth in some supports growth, namely Kosovo, Montenegro WB6 countries could benefit from increases and Serbia, and those such as Bosnia and in FDI (such as, for example, investments in Herzegovina and North Macedonia, where the Serbian automotive sector). Meanwhile, lower external demand and domestic fiscal there are further risks to the outlook, mainly pressures cause slower growth. stemming from: (i) weak EU growth and trade FIGURE 9.1. impacting trade and remittances; (ii) domestic factors, including continued outmigration, Contribution to growth, spring vs. autumn projections national elections, etc.; and (iii) the impact of the recent drought. 10.0 Consumption Exports Investment Imports Inflation is expected to continue its 8.0 downward path, in line with international 6.0 trends. The latest projections indicate that in 4.0 2024 inflation will reach 3.4 percent instead 2.0 of previously projected 3.9 percent. Lower expected inflation of imported goods is the 0.0 main contributor to this slowdown, given that -2.0 domestic demand will increase even faster than -4.0 previously projected. However, as previously -6.0 spring autumn spring autumn spring autumn mentioned, the recent drought may have 2024 2025 2026 an inflationary impact on food prices (both in 2024 and 2025), and on the overall CPI Source: National statistical offices and World Bank staff calculations thereafter. The Economic Sentiment Indicator (ESI) remains strong in the WB6 countries.34 The The structural reform agenda remains critical ESI has increased since February and remains in order to retain the growth momentum well above its historical averages (Figure 9.2). toward more sustainable improvements This has been driven by mounting confidence in living standards and closer economic in services and retail trade and, to a lesser integration. Priority reforms are those that: (i) extent, in industry. Confidence in construction capitalize and build on WB6 countries’ human has been recovering only since July, while capital potential; (ii) support firm to grow and consumer confidence has continued to increase their productivity; (iii) leverage higher decline. Among the surveyed WB6 countries, connectivity through increased competition ESI performance is particularly strong in and high quality foreign investment. In Montenegro and Albania, and slightly less so Kosovo and Bosnia and Herzegovina, the in Serbia, while in North Macedonia is has focus should be on labor market and social started to decline since August. protection reforms that would help increase labor force participation, including higher There are some additional factors that could participation of women in labor markets. both increase or decrease projected growth. Expanding childcare services would not only First, there are additional opportunities for improve labor market opportunities for women financing infrastructure (i.e., the new Growth but also enhance children’s school readiness Plan for the Western Balkans), as well as to through better early childhood education. In 34 The Economic Sentiment Indicator (ESI) is a composite indicator combining judgements and attitudes of businesses (in industry, construc- tion, retail trade, and services) and consumers by means of a weighted aggregation of standardized input series. It is published monthly by DG EFIN: https://economy-finance.ec.europa.eu/economic-forecast-and-surveys/business-and-consumer-surveys_en The growth outlook: diverging growth drivers 59 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Bosnia and Herzegovina, efforts are needed to wind, and hydro generation capacities. The advance with digitalization and unification of EU pre-accession funds can supplement the the main databases relevant for businesses. In limited public resources in the WB6 countries, this context, sound macro-fiscal management but these funds can cover only a part of the is a key prerequisite for WB6 countries’ total investment needs described. The rest macroeconomic stability and growth over the should come from the private sector through medium and longer term. While Montenegro different mechanisms. Investments will need and Albania need to proceed with proposed to be accompanied by regulatory reforms, revenue mobilization measures, Serbia needs including but not limited to: (i) adoption of to contain the growth of the fiscal deficit by the carbon price; (ii) harmonization of the carefully managing the pressures deriving from power sector’s legal and regulatory frameworks the capital budget. for the integration into the pan-European electricity market; (iii) investing in training Transition to net zero will require substantial and reskilling of existing labor; (iv) structural investments, predominantly to be made by changes in the education system over the the private sector, with governments playing longer term; and (v) increased coverage and a complementary role (see Box 9.2). Most of adequacy of social protection and health the investments would be channeled into systems. decarbonizing transport and scaling up solar, FIGURE 9.2. Economic Sentiment Index 2021–2024 Average 2000–2023=100 Consump�on Western Balkans EU 130.0 120.0 110.0 100.0 90.0 80.0 70.0 60.0 Jul-21 Jul-22 Jul-23 Jul-24 Jan-21 Sep-21 Nov-21 Mar-21 Jan-22 Jan-23 Jan-24 May-21 Sep-22 Nov-22 Sep-23 Mar-22 Mar-23 Nov-23 Mar-24 May-22 May-23 May-24 Source: European Commission. Note: Simple average for the WB6 countries. 60 The growth outlook: diverging growth drivers RETAINING THE GROWTH MOMENTUM Box 9.1: Escaping the middle-income trap: Insights for the Western Balkans from the new World Development Report Since the term “middle-income trap” was first coined 20 years ago, there has been concern that the shift to the policies needed to enable growth in a middle-income country (MIC) from those needed to enable growth as a low-income country (LIC), is not easy.35 Globally, 27 countries have transitioned from middle- to high-income since 1990. Of these, 13 have been EU member states, including 11 countries that were World Bank clients in the 1990s. What has become known as the EU “convergence machine”— through institutional change, trade, investment, and flow of capital and managerial expertise from richer to poorer countries—has helped all its member states to overcome the middle- income trap.36 The remaining countries include economies with very substantial natural resource endowments, large dependence on tourism, and the economies of the Republic of Korea and Uruguay. Countries that neither have large natural resource endowments nor implemented significant structural reforms have seen a slower pace of convergence to high income status. Having undergone three decades of transition from a planned to a market economy, Europe and Central Asia (ECA) is a solidly middle-income region, with ambitions to escape the middle-income trap and converge to high income. In ECA, MICs account for 75 percent of regional economic activity, 85 percent of the region’s population, nearly 90 percent of the people living in poverty, and nearly 90 percent of CO₂ emissions. All the WB6 economies are classified as MICs. The median ECA MIC has an income per capita of about one-third that of the United States, up from one-fifth for the average MIC around the world. The chances of their transitioning to high income status have deteriorated in the context of slower global growth and weaker growth potential, fragmented global value chains, increased geopolitical tensions, and rising populism. Even without these headwinds, MICs face long odds with respect to becoming HICs and escaping the middle-income trap. The need to achieve growth while also decarbonizing adds new challenges to today’s MIC policy makers compared with those that went before them. A new World Development Report (WDR) focusing on how countries can escape the middle-income trap offers new insights, including a “Schumpeterian lens” to development, with an emphasis on the extent to which institutions encourage (or discourage) creative destruction.37 Modern Schumpeterian growth theory brings new ideas about the role of creative destruction in driving economic growth. A key stylized fact of this theory is that technological progress must continue through new innovations. But innovation does not take place in a vacuum, as firms or individuals incur costs and take risks to innovate. So, to fully understand the underlying drivers of economic development, it is necessary to connect the macroeconomic structure of growth with microeconomic determinants such as the incentives, policies, and organizations that interact with the 35 Gill, I. and H. Kharas. 2007. An East Asian Renaissance: Ideas for Economic Growth, Washington, DC: World Bank. 36 Gill, I., and M. Raiser. 2012. Golden Growth: Restoring the Lustre of the European Economic Model. Europe and Central Asia Stud- ies, Washington, DC: World Bank. 37 https://www.worldbank.org/en/publication/wdr2024. The growth outlook: diverging growth drivers 61 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 growth process—including how winners, losers, and rents associated with innovations are allocated and awarded. The Schumpeterian process of creative destruction can be viewed through three overlapping dimensions, as follows: • Creation. The key extent to which governments facilitate or blunt the natural force of creation in the entry of new businesses, new innovations, and innovative ideas both at home and from abroad. • Preservation. The extent to which governments allow for the preservation of existing players to function as a blocking force either by protecting incumbents or allowing incumbents to impede market competition. • Destruction. The necessary process that allows for scarce resources to be reallocated to their most efficient use, and often takes place the most during economic crises, yet (for myriad reasons) governments often limit the extent to which they allow the process of destruction to take place. Empirical work on the economics of creative destruction has highlighted the economy- wide risks associated with a lack of Schumpeterian institutions. These risks include increased market concentration, higher markups and profit margins, lower labor shares of output, a large productivity gap between industry leaders and other competitors, declining firm entry rates, weak survival of young firms, and weakening job reallocation and churn. This critique seems particularly relevant for the WB6 economies that are exhibiting slowing convergence. Hence, the fears of a middle-income trap in the WB6 region amid a struggle to effectively make the leap to an innovation-based growth model. The 2024 WDR offers a roadmap, termed as a 3I approach, implying that MICs need to navigate two important and sequential development transitions to successfully become high income. The LIC-to-MIC transition shifts from accelerating investment (a 1I strategy) to focusing on both investment and infusion (2Is), which brings ideas, practices, and technologies from abroad and diffuses them domestically. The MIC-to-HIC transition then necessitates a shift to increased innovation (3Is), not only borrowing ideas from abroad but also pushing out the technology frontier at home. • Investment, the first I. Foundational reforms are necessary to maximize the fundamental drivers of economic growth, including investing in and maximizing the returns associated with scarce physical and human capital. Foundational investments, policies, and institutions facilitate sustainable increases in public and private investment. They also unlock the full potential of human capital in both quantity (to ensure full labor force participation) and quality (education and skills formation). And they efficiently allocate and productively use physical and human capital. • Infusion, the second I. Structural reforms—to enable the transition from 1I to 2Is— are more complex institutional arrangements needed to sustain Schumpeterian creative destruction in a new and more challenging external environment. This requires a policy framework that allows for the creative destruction process to freely take place. This 62 The growth outlook: diverging growth drivers RETAINING THE GROWTH MOMENTUM framework will vary depending on the relative stage of an individual country’s level and stage of development. In its simplest form, countries at the earlier stage of their transitions from MIC to HIC status need to focus primarily on reforms that level the playing field to attract new private investments, particularly from abroad, to enable the infusion of ideas, practices, and technologies across the economy. • Innovation, the third I. Transformative reforms—to enable the transition from 2Is to 3Is—would come as countries approach the HIC threshold, with a particular focus on managing the incumbency advantage associated with the behavior of existing firms in the market. Countries seeking to sustain growth beyond the HIC threshold need policies and institutions that allow for growth at the frontier, reducing the risk premium associated with innovation by firms. FIGURE 9.3. To achieve high-income status, countries will need to recalibrate their mix of investment, infusion and innovation policies Income Classification Investment Infusion Innovation Low-income Higher priority Lower priority Lower priority Low-middle-income Higher priority Higher priority Lower priority Upper-middle-income Higher priority Higher priority Higher priority Source: World Development Report 2024. Tellingly, experience from past high-income transitions in the region points to the need for higher ambitions and a deeper commitment to reform efforts among ECA’s current set of middle-income economies, including those in the Western Balkans. The growth outlook: diverging growth drivers 63 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Box 9.2: Responding to climate change in the Western Balkans38 The WB6 region will be subject to varying degrees of economy-wide damage from climate hazards. In recent years, the WB6 region has seen a surge in heat-related stressors— mainly heightened temperatures and intensified droughts—that threaten to undermine regional stability and productivity. The average temperature for the region increased by 1.2°C compared with 1961–80, while precipitation decreased by 0.2 percent but at the same time showed higher volatility. A model39 analyzing the impacts of three climate hazards—riverine floods, droughts (via the impact on maize and wheat), and labor heat stress—indicates that Serbia is expected to experience the most significant damage under RCP 4.540 and trend growth, followed by Bosnia and Herzegovina (Figure 19). Floods are expected to cause the most significant damage to GDP in all WB6 countries, ranging from about 15 percent loss in 2050 GDP for Serbia and about 3 percent of GDP loss for North Macedonia under the trend growth. FIGURE 9.4. Percent reduction in 2050 GDP from selected climate hazards under RCP 4.5 Trend growth (breakdown) and optimistic growth (combined impact) Labor Heat Stress -Trend growth Drought (via Maize & Wheat Yields) -Trend growth Flooding -Trend growth Combined impact -Optimstic gowth Without Adaptation With Adaptation ALB BIH KOS MNE MKD SRB ALB BIH KOS MNE MKD SRB 0 -4 -8 -12 -16 -20 Source: 2024 Western Balkans 6: Country Climate and Development Report (CCDR). However, damage from climate risks can be alleviated through adaptation investments and early interventions. The costs of these investments are high—with a regional annual average of 1.5 percent of GDP in 2025–2030, 1.3 percent in 2031–2040, and 1.2 percent in 2041–2050.41 Yet, the benefits are even higher and could lead to transformation through avoided losses, accelerated economic potential, and amplified social and environmental spillovers. Looking at investment costs and benefits, annual investments averaging 1.3 percent of GDP across the region for 2025–2050 could yield an average annual benefit of 1.7 percent of GDP and a benefit to cost (BCR) ratio of 1.6. The estimated initial, comprehensive multi-sectoral adaptation investment package42 comes to a total for the region of US$37.2 billion (in 2020 US$) undiscounted (Table 9.2). 38 Based on the 2024 Western Balkans 6: Country Climate and Development Report (CCDR) available at: https://www.worldbank. org/en/region/eca/publication/western-balkans-6-ccdr 39 Climate-enhanced macro-structural model of the World Bank, MFMOD. 40 RCPs (Representative Concentration Pathways) are scenarios describing GHG-trajectories and their climate impacts. The most stringent pathway is RCP 1.9, which limits global warming to below 1.5 °C. RCP 4.5 is an intermediate scenario with emissions peaking by 2040. The high-emission scenario is RCP 8.5, where emissions continue to rise throughout the 21st century. 41 The assessment accounts only for direct impacts on GDP. 42 This analysis was completed based on data gathered from local documents, literature, and expert knowledge. 64 The growth outlook: diverging growth drivers RETAINING THE GROWTH MOMENTUM TABLE 9.2. Undiscounted costs of proposed policy actions and investments for an initial detailed adaptation package (in 2020 US$ billion, US$ undiscounted) WB6 Albania Bosnia and Kosovo Montenegro North Serbia Herzegovina Macedonia Adaptation 32.7 6 6.8 2.8 5.7 6.4 9.5 Source: Source: 2024 Western Balkans 6: Country Climate and Development Report (CCDR). While decarbonization is required to meet emissions commitments and achieve economy- wide net zero emissions by 2050, this can be achieved without compromising WB6 economic growth potential. The economic costs of the transition to a net zero emission scenario vary by country, according to the modeling done for the Country Climate and Development Report (CCDR), in terms of GDP per capita growth: half of the countries will have higher growth rate in the net zero (NZ) than the reference scenario (RS)43 for 2030 and 2040, although most will have a small negative difference in 2050. Under trend growth, the levels of GDP per capita (in 2020 US$) are expected to be smaller under NZ than under RS by less than 1 percent of GDP in 2050 in all countries, except Bosnia and Herzegovina (-1.17 percent lower GDP per capita level). These results include the positive offsetting impact that externalities have on GDP through investments, the impact of lower air pollution, lower road accidents, and lower road maintenance. TABLE 9.3. Estimated CAPEX44 of mitigation measures under trend growth by 2050 (US$ billion, US$ discounted at 6 percent) WB6 Albania Bosnia and Kosovo Montenegro North Serbia Herzegovina Macedonia Mitigation CAPEX 32.0 5.3 5.8 4.7 0.2 5.6 10.4 Source: Source: 2024 WB6: Country Climate and Development Report (CCDR). Transition to net zero will require substantial investments, predominantly made by the private sector, with governments playing a complementary role. The average annual gross incremental adaptation and mitigation investment (without considering benefits) through 2050 come to 1.3 percentage points of GDP and 1.9 percentage points of GDP , respectively. The estimates are sizable, given that the 20-year average total investment rate for the WB6 region is about 27 percent of GDP and the public investment rate is about 7 percent of GDP . Considering mitigation costs, compared with RS, the WB6 would need to invest an additional US$32.0 billion discounted at 6 percent45 to achieve NZ (Table 9.3). Most of the investments would be channeled into decarbonizing transport and scaling up solar, wind, and hydro generation capacities. The transition will necessitate attracting private sector financing beyond current levels while advancing sectoral reforms to entice private capital and bridge the climate mitigation investment gap. It is estimated that about 85 percent of the total investment required to achieve the net zero goal by 2050 could be made by the private sector under adequate enabling conditions (Figure 20 and Figure 21). 43 Net zero scenario assumes reaching zero greenhouse gas (GHG) emissions by 2050, while the reference scenario assumes the business-as-usual scenario. 44 Capital Expenditure. 45 In this summary, the costs of the initial adaptation investment package are presented as undiscounted lupsusms due to their immediate or short-term benefits (5-10 years); mitigation costs are discounted because they involve long-term investments with benefits accruing over time (25 years). The growth outlook: diverging growth drivers 65 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 FIGURE 9.5. Note: For Serbia, for both public and private investment, the Incremental public investment under trend growth, percent level of investment under net of GDP zero is less than the level of investment in the RS. However, 1.0% ALB the composition of investment BIH differs under the two scenarios. 0.8% KOS For Montenegro, the level of MNE investment under the net zero 0.6% MKD and the RS are about equal after SRB 2041. 0.4% Avg Avg OPT 0.2% 0.0% -0.2% -0.4% 2026 2031 2036 2041 2046 2050 Source: 2024 WB66: Country Climate and Development Report (CCDR). FIGURE 9.6. Note: For Serbia, for both public and private investment, the Incremental private investment under trend growth, level of investment under net zero is less than the level of percent of GDP investment in the RS. However, the composition of investment 5.0% ALB differs under the two scenarios. BIH For Montenegro, the level of 4.0% KOS investment under the net zero MNE MKD and the RS are about equal after 3.0% SRB 2041. Avg 2.0% Avg OPT 1.0% 0.0% -1.0% 2026 2031 2036 2041 2046 2050 Source: 2024 WB6: Country Climate and Development Report (CCDR). Financing needs mandate access to EU and partner funding, and also developing new in-country financial products and services. The EU pre-accession funds46 can supplement the limited public resources in the WB6 countries but they can cover only a part of the total investment needs described. The rest should come from the private sector through different mechanisms. Domestically, the WB6 region’s low savings rate (19 percent in 2022) requires encouraging savings activity in the long term. Also, banks and non-bank financial institutions, including institutional investors, can play a critical role in providing long-term green financing through equity and debt channels. 46 The European Commission’s 2020 Economic and Investment Plan allocates up to €9 billion in EU funds for 10 investment flag- ships, addressing various needs such as transport, renewable energy, and youth employment. The EU Western Balkan Guarantee Facility aims to mobilize up to €20 billion in investments, thereby reducing financing risks. 66 The growth outlook: diverging growth drivers RETAINING THE GROWTH MOMENTUM Investments will need to be accompanied by regulatory reforms, as well as incentives to change behaviors: adoption of the carbon price is one example. Creating an enabling environment for green finance is a necessary but insufficient measure to attract low-carbon investment at scale. Aspects such as the adoption of carbon pricing, to also limit the impact of the Carbon Border Adjustment Mechanism (CBAM),47 and harmonization of the power sector’s legal and regulatory frameworks for the integration into the pan-European electricity market are critical. Consequently, having a clear, coordinated, and consistent financial and energy markets reform plan will be crucial for boosting confidence among investors to scale up renewable energy investment in the WB6 region. Enabling just transition—based on effective and adequate social protection, education, and health systems—is a prerequisite for the green transition. Investing in retraining and upskilling is essential to avoid unemployment risks and ensure that firms have an adequately skilled workforce. Already about 417,000 people across the WB6 countries (excluding Montenegro) are in occupations with a high risk of being impacted by the green transition and this will likely double. Estimates show that the cost of retraining and reskilling those workers most at risk may reach €700 million if they were to be retrained into alternative occupations that are not likely to be impacted by the green transition, and €2.4 billion if they were to be retrained into alternative green jobs. In the longer term, more structural changes in the education system will be needed. To reduce the risks and uncertainty of the green transition on people’s incomes, consumption, and health, increased coverage and adequacy of social protection and health systems are needed across the WB6 region. 47 From October 2023, the EU’s CBAM imposes fees on imported goods, initially targeting the iron and steel, cement, fertilizers, aluminum, electricity, and hydrogen sectors. Importers of these goods are obligated to purchase CBAM certificates, the price of which is linked to the average price of EU ETS allowances and the required number of certificates is based on the carbon content of the goods, including both direct and indirect emissions. From October 2026, the CBAM certificates will be gradually phased in and the allocation of free allowances to EU ETS entities will be phased out. The growth outlook: diverging growth drivers 67 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 10. Spotlight: Reaping the Benefits of a Global Workforce Migration has been a characterizing feature of the Western Balkans for decades, shaping the lives, livelihoods and aspirations of its population. While Western Balkans (WB6) countries have some of the largest emigration rates in the world, foreign workers are increasingly present in the region to fill emerging labor shortages. Both emigration of WB6 nationals and immigration of foreigners are expected to continue in the coming years, drawing the attention on the importance of well-designed and carefully implemented policies to unlock the benefits of international mobility in the region. In fact, despite a progressive convergence of incomes in recent years, differentials in economic opportunities and quality of services with Western European countries remain large, fueling intentions to emigrate. As such, a critical question is how to make migration yield positive impacts for the Western Balkans economies while at the same time ensuring the safety and prosperity of both migrants and their communities left behind. In recent years, WB6 countries have made significant efforts to improve the management of migration flows and strengthen their developmental impacts. However, gaps still remain. By shedding light on trends, characteristics, impacts and current policy efforts in the area of migration in the WB6, this Spotlight aims to inform actions that can help Western Balkans economies leverage migration for their development. On the Move: Unpacking Western Balkans Migration Dynamics Close to one in four people from the WB6 (1.7 million and 1.4 million, respectively) resides abroad. Today, around 5 million and as a share of their populations (34 and people who were born in the WB6 countries 32 percent, respectively).48 Around one in five live abroad (Figure 10.1a). The disintegration citizens from Kosovo and North Macedonia are of the former Yugoslavia and the subsequent also living abroad (Figure 10.1b). Emigration conflict led to rapid migration outflows, with rates are lower in Serbia (12 percent), although the number of emigrants doubling from 2 emigration is still sizable in absolute numbers. to 4 million between 1990 and 2000. Since Intentions to emigrate from the region remain then, the stock of emigrants has continued to high and have been rising over the past five grow, although at a slower pace. Bosnia and years, with 44 percent of adults in 2023 Herzegovina, and Albania are the main sending considering living and working abroad.49 countries in the region, both in terms of stocks 48 World Bank KNOMAD Bilateral Remittance Matrix 2021, December 2022. 49 Balkan Barometer Public Opinion survey (2023). 68 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM FIGURE 10.1. Stock of emigrants from Western Balkan countries in 2021 a. Stock of emigrants b. As a percentage of the total national population 1800 40% Number of emigrants (thousands) 1600 35% Share of total nationals (at home and abroad) 1400 30% 1200 25% 1000 20% 800 15% 600 400 10% 200 5% 0 0% Albania Bosnia and Herzegovina Kosovo Montenegro Macedonia Serbia Albania Bosnia and Herzegovina Kosovo Montenegro North Macedonia Serbia North Source: World Bank KNOMAD (2022). Box 10.1: Data source and challenges to estimate migration numbers Migrant origin and destination countries around the world face challenges in collecting data on the stocks and flows of migrants, leading to conflicting—and generally undercounted—numbers. In destination countries, census data, as well as administrative data and surveys, capture immigration based on the country of birth and, in some cases, citizenship. Census data are the most accurate, however, they do not capture rapid changes in migration patterns, given that they are collected every 5-10 years. They also tend to undercount certain groups such as undocumented migrants or hard-to-reach refugees. Estimates of migrants also vary depending on the definition, which is usually based on either the country of birth or on citizenship. For example, Germany, which reports statistics of migrants based on citizenship, does not provide information on those migrants that were born abroad but obtained German citizenship. In general, data sources from sending countries suffer from more identification problems in capturing the whole extent of emigration. This is particularly the case for those migrating informally or when entire households leave a country. Throughout this spotlight, migrants are considered to be those who reside in a country that is different from their place of birth, irrespective of their citizenship. The main data source for the stock of Western Balkan emigrants comes from the World Bank’s Global Knowledge Partnership on Migration and Development (KNOMAD) database, which compiles information from censuses and other administrative and survey data in destination countries. These data are complemented with information on work permits issued by EU destination countries from Eurostat. Spotlight: Reaping the Benefits of a Global Workforce 69 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 FIGURE 10.2. Main destination countries and regions of Western Balkan emigrants a. Share by destination region (2021) b. Trends in first permits for WB6 migrants in Europe EU14-north EU14-south EU NMS Other EFTA+UK Western Bakans Rest of the world Austria Croatia 100% Greece 300,000 Slovenia 90% Italy 80% Germany 250,000 70% 60% 200,000 50% 40% 150,000 30% 20% 100,000 10% 0% 50,000 Bosnia and Montenegro Herzegovina Macedonia Albania Kosovo North Serbia 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Source: World Bank KNOMAD (2022) and Eurostat. Note: Note: EU14 North = Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Luxembourg, the Netherlands, and Swe- den; EU14 South = Greece, Italy, Portugal and Spain; EU NMS (EU New Member States) = Bulgaria, Croatia, Cyprus, Czechia, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia, and Slovenia; EFTA + UK = Iceland, Lichtenstein, Norway, and the United Kingdom; Western Balkans = Albania, Bosnia and Herzegovina, Kosovo, Montenegro, North Macedonia, and Serbia. WB6 emigrants are highly concentrated in economic opportunities has been a common thread European countries, although important throughout the years. While the decision to move variations exist by country of origin. The is rooted in a diverse set of economic, political, vast majority of Albanian emigrants go to social, or humanitarian reasons, all migrants either Greece or Italy. Montenegrin emigrants move in search of a better life for themselves and mostly reside in Serbia. In turn, emigrants their families. The redrawing of the borders of the from Bosnia and Herzegovina, Kosovo, North former Yugoslavia and the subsequent conflict in Macedonia or Serbia tend to move to Western the region in the 1990s led to strong waves of European countries such as Germany, Austria forcibly displaced populations, both internally or Switzerland, although there are also flows and internationally.50 In recent years, economic driven by ethnic ties. In the case of North motives have been the main driver for emigration. Macedonia, one fourth of its emigrants reside Most migrants move in search of better in Türkiye, mostly ethnic Turks. Recent employment opportunities and higher wages. trends in the issuance of new permits to WB6 Employment rates in the WB6 countries are emigrants in Europe show that neighboring significantly below those observed in destination countries such as Croatia and Slovenia have countries (60.3 percent in 2023, compared with become increasingly more prevalent as a 70.4 percent in the EU).51 Moreover, wages destination since they joined the European in more advanced EU economies are as high Union (EU) in 2004 and 2013, respectively. as three times those of countries in the WB6, even after taking into consideration differences Historically, people from the Western Balkans have in the cost of living (Figure 10.3a). These wage moved for different reasons, but the search for better 50 By 1995, there were 770,000 Bosnian refugees displaced in third countries, which represented more than half of the total Bosnian migrants at that time. Conflict also displaced more than 850,000 Kosovars in third countries by the end of 1998/99 (OECD, 2022). 51 These figures refer to the working age population in each region (Eurostat and ILOSTAT 2024). 70 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM FIGURE 10.3. Wage differentials across Europe and net migration a. Average Annual Earnings by country in 2022 (2021 b. Wages in 2010 and net migration Purchasing Power Parity adjusted) (2011–20) 9000 20 Net migration 2011-20 (% of the population in 2020) Average Monthly Net Earnings (2021 PPP) 8000 15 7000 10 ISL CHE 6000 SWE 5 CYPAUT NOR 5000 DNK DEU BEL ITA HUN EST CZE SVN GBRFIN NLD 4000 0 SRB PRT MKD EST FRA ESP IRL BGR ROU SVK POL 3000 ALB HRV GRC MNE -5 LVA 2000 -10 BIH 1000 -15 KOS 0 KOS SRB SVK CZE HUN ALB BEL NLD ESP CHE POL MNE LUX DNK LVA SWE EST FRA LTU IRE NOR HRV GRC BGR BIH SVN DEU AUT FIN ROU MKD ITA -20 6.5 6.7 6.9 7.1 7.3 7.5 7.7 7.9 8.1 8.3 8.5 Western Europe NMS13 EU Western logarithm of monthly wages in 2010 (USD PPP) Balkans Source: Ilostat (2023). Source: Adjusted from Bossavie, Garrote-Sanchez and Makovec (2024). “The Journey Ahead: Supporting Successful Migration in Europe and Central Asia,” Europe and Central Asia Studies Series, Washington, DC: World Bank, based on Eurostat, Ilostat and World Bank World Development Indicators. differentials are not just driven by differences in The profile of emigrants from different workers’ productivity but also by what is called Western Balkan countries is diverse but with the “place premium”. In Europe, countries with some commonalities. WB6 emigrants are lower wages are associated with higher emigration concentrated among the prime age population (Figure 10.3b). More lenient migration policies compared to both natives in host countries and in destination countries in Europe have also been the non-migrant population at origin, consistent a main pull factor in attracting migrants from the with employment being a primary driver of WB6 countries. For example, the passing of the emigration. Eighty-five percent of the WB6 Western Balkan regulation in Germany in 2015 emigrant population are of working age compared increased formal labor migration pathways for to 66 percent of non-migrants (Figure 10.4a). both high- and low-skilled migrants. Given the This rate is particularly high in Albania, Bosnia size of the WB6 diaspora, family reunification is and Herzegovina, and Kosovo. Intentions to another key factor for migration, with 45 percent migrate are also consistently higher for the youth of new permits issued to WB6 emigrants by the than the general adult population.56 With respect EU between 2013 and 2022 being granted for this to gender, the stock of WB6 emigrants tends to purpose.52 Dissatisfaction with the quality of the be neutral, with 51 percent being males (Figure education and health systems has also been found 10.4a). However, the predominance of male to be a relevant push factor to emigrate.53 Beyond emigration has surged in recent years, especially economic factors, research also finds that perceived in Bosnia and Herzegovina (75 percent) and corruption and nepotism also influence the decision Kosovo (70 percent) (Figure 10.4b). The gender to emigrate from the WB6.54,55 profile of emigrants varies across countries of 52 Eurostat (2024). 53 European Training Foundation (2022). 54 López García, A.I., and B. Maydom (2023): “Frontline corruption and emigration in the Western Balkans,” Migration Studies, 11(4): 694–720. 55 Malaj and Firza (2023): “The Impact of Corruption on Migration: Evidence from the Western Balkans,” Migration Letters, 20(8): 896–907. 56 Seventy-one percent of the population aged 18 to 24 in the Western Balkans intend to migrate abroad, compared with 44 percent of the general adult population (Balkan Public Barometer Survey, 2023). Spotlight: Reaping the Benefits of a Global Workforce 71 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 FIGURE 10.4. Profile of emigrants from the Western Balkans in OECD countries a. Total emigrant population (2015) b. Emigrants arriving in EU and EFTA in 2018–22 100% ALB ALB MNE BIH 100% BIH MKD 90% KOS SRB KOS 90% 80% MNE 70% MKD 80% 60% SRB 70% 50% 60% 40% 50% 30% 40% 20% 30% 10% 20% 0% 10% Male Working age High education 0% (15-64) Male Working age (15-64) Source: OECD-DIOC (2015/16) and Eurostat (2018–2022). origin and types of migration. While migration occupational downgrade representing a major of forcibly displaced groups is gender neutral challenge. Employment rates among WB6 adult or with a higher share of women, migration migrants in OECD countries ranged between for economic purposes—especially seasonal or 61 and 71 percent for men, and between 37 temporary—is more male-dominated. Survey and 57 percent for women, according to OECD data of migrant households in WB6 that better statistics for 2015 (Figure 10.5a). In each of capture short-term migration episodes show that the six countries, these rates were significantly around 75–80 percent of household members higher than those of non-migrants during the abroad in Albania, Bosnia and Herzegovina, same period (43–53 percent for men and 25–39 Kosovo, Montenegro, and North Macedonia are percent for women). The positive employment male.57 The educational profile has traditionally gaps for migration is particularly large for shown low levels of education: only one in six women and lower-skilled workers, and it is not WB6 migrants in 2015 had tertiary education, fully explained by differences in demographic below the rates of the non-migrant population characteristics. Nonetheless, WB6 emigrants at that time (Figure 10.4a).This rate is slightly in OECD countries face challenges in the lower than that of the non-migrant population labor market, with high rates of occupational in the Western Balkans for the same year.58 The downgrade. Among emigrants with tertiary prevalence of highly educated emigrants is the education, 46 percent of men and 41 percent lowest in Kosovo (8 percent), North Macedonia of women are overqualified for their jobs, an (12 percent), and Albania (13 percent). More issue particularly prevalent for those originating recent data suggest that WB6 emigrants’ from Kosovo and Albania (Figure 10.5b). These education levels have been increasing over the rates are higher than those of natives in main past decade, with more than 20 percent having destination countries such as Germany (16%), tertiary education.59 or Austria (27%). Western Balkans emigrants tend to have better The emigration of citizens of WB6 employment outcomes than non-migrants, countries is not only a one-way story, as a although gaps remain with respect to the portion of them, especially in some of the population in host OECD countries, with countries, do return at some point in their 57 Life in Transition Survey (LiTS 2024). 58 18% according to the World Development Indicators of the World Bank. 59 Ibid. 72 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM lives. Available statistics from the cohorts of Europe. Less than two-thirds of them were displaced populations from war and conflict forced to return due to their irregular status show a large volume of returns. In Kosovo, abroad, while the other one-third did so the vast majority of refugees returned in the voluntarily.62 In Bosnia and Herzegovina and years following the 1999 Peace Accords.60 Kosovo, the number of returnees tend to be In Bosnia and Herzegovina, the return of low compared with the size of their emigrant refugees was slower, with 60 percent of them population. However, ad-hoc surveys in still residing abroad 10 years after the end of origin countries such as Albania and Kosovo the war.61 Statistics of the return of economic suggest that return migration might be a more migrants are scarcer and usually limited to prevalent phenomenon.63 In Albania, flows of assisted returns or forced repatriation, which return migrants have been consistently sizable. is an undercount of the total return flows. In Between 2001 and 2011 around 140,000 the past decade (2013–22), close to 120,000 migrants returned to the country, and another WB6 emigrants left their host countries in 108,000 returned between 2011 and 2023.64 The Ripple Effect: Migration’s Role in Shaping WB6’s economic development Moving across borders often results in opportunity for potential emigrants and their significant welfare gains for migrants and families to increase their incomes. While part their families. The large wage and employment of these wage differentials is due to different differentials observed between the WB6 and workers’ productivity across countries, it has other European countries provide a unique been shown that the same individuals can FIGURE 10.5. Labor market outcomes of Western Balkan emigrants in OECD destination countries a. Employment rates of WB6 emigrants in OECD countries b. Share of overqualified tertiary educated emigrants ALB BIH KOS MNE MKD SRB Male Female 90% 70% 80% 60% 70% 60% 50% 50% 40% 40% 30% 30% 20% 10% 20% 0% 10% Total Total Low-educ Mid-educ High-educ Low-educ Mid-educ High-educ 0% ALB BIH KOS MNE MKD SRB Male Female Source: OECD DIOC database 2015/16 and EU-LFS 2015. Note: The share of over-qualified tertiary educated migrants shows the proportion of tertiary-educated migrant workers employed in a low- or medium-skilled occupation in their destination country (international standard classification of occupations (ISCO) major groups 4–9). 60 Around 600,000 of the 850,000 forcibly displaced (OECD, 2022). 61 Ministry of Human Rights and Refugees of Bosnia and Herzegovina (2006). 62 Eurostat (2024): “Third-country nationals who have left the territory by type of return and citizenship [migr_eirt_vol__cus- tom_11968055]”. 63 For example, a recent survey conducted in 2022 by Kantar found that 17 percent of the population 18 to 65 had worked abroad, which would suggest a total population of returned migrants of around 200,000. 64 Albanian Census of 2011 and 2023 (Instat and IOM, 2013, 2020, and Instat, 2024). Spotlight: Reaping the Benefits of a Global Workforce 73 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 earn significantly more just by moving.65 for countries in the Western Balkans. For One key motivation behind the decision to origin countries, the mobility of a part of their migrate, particularly among labor migrants, populations can serve to increase the inflows of is the ability to send remittances to relatives international remittances. In WB6 countries, and acquaintances back home. Close to 70 remittances amounted to US$13.8 billion, percent of WB6 emigrants send remittances equivalent to an average of 6 percent of GDP home.66 Remittances are a key source of in 2023 (Figure 10.6). They range from 2.5 income for WB6 recipient households and percent of GDP in North Macedonia to 13.4 support poverty reduction among vulnerable percent in Kosovo.69 Moreover, remittances households in the region.67 Remittance- tend to be more stable than capital flows, and recipient households mostly use this additional are more countercyclical in nature.70 income for consumption, especially consumer goods and, to a lesser extent, in real estate. For Beyond remittances, the benefits of an example, consumption represents 60 percent internationally mobile population can be of those transfers in Bosnia and Herzegovina, significant. Countries of origin can benefit compared with 15 percent on investments in from having a mobile population, both from education.68 those that remain abroad and those who return to the country. The diaspora can channel At the macro level, remittances represent international savings, transfer know-how an important and stable source of funding and new technologies, and link the economy FIGURE 10.6. Remittances in WB6 countries as a share of GDP (2023) 14 12 Share of GDP 10 8 6 4 2 0 BiH Montenegro Macedonia Albania Kosovo North Serbia WB6 Source: World Bank staff calculations based on country statistical offices and central banks data. 65 Clemens, Montenegro, and Pritchett (2019). 66 World Bank Life in Transition Survey IV (2024). 67 Petreski and Jovanović (2013) for North Macedonia; Dushku (2019) for Albania; and Möllers and Meyer (2014) for Kosovo. 68 IOM (2020). 69 Official statistics tend to underestimate the total volume of remittances, which partly come through informal channels. In North Macedonia a larger share of remittances is recorded as cash exchange on FX markets in the balance of payments, and the Central Bank of North Mace- donia incorporates the two categories for a more accurate overview of remittances. 70 Frankel (2011). 74 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM to global business networks.71 All of this can percent), a pattern observed for more than spur productivity, exports, entrepreneurship two decades.74 Studies have also found that the and job creation.72 Globally, a higher presence return of refugees back to the Western Balkans of the diaspora in a destination country is after the 1990s war led to increases in firms’ associated with larger inflows of FDI from exports.75 Ad-hoc surveys in Kosovo reveal that that country to the origin country, pointing the vast majority of returnee entrepreneurs to the fundamental role of the diaspora in gained valuable experience, knowledge, skills, attracting international capital.73 Some of these and global business networks during their positive effects may be occurring in the WB6 migration experience.76 Positive spillovers countries. FDI inflows in 2022 ranged from from the return of part of the diaspora have 3.0 percent in Bosnia and Herzegovina to 13.2 also been observed in Albania, improving percent of GDP in Montenegro, but overall employment rates and wages of non-migrants, the WB6 countries are well above the average and boosting GDP (see Box 10.2).77 for peer upper middle-income countries (1.3 Box 10.2: The impact of Albanian returnees after the crisis in Greece The sovereign debt crisis in Europe at the end of the 2000s hit Greece particularly hard. As a result, employment drastically fell, reducing the opportunities for Albanian emigrants to obtain sustainable incomes. Many emigrants decided to return to Albania, which led to an increase in the labor force in the country of 5 percent between 2011 and 2014. This sudden shock of return migrants, who mostly located back in their localities of origin, led to positive spillovers in the local economy. Evidence shows that many returnees were engaged in entrepreneurial activities, creating jobs not just for themselves but also for the non-migrant population.78 For every 1-percentage-point increase in returnees in a given district, employment rates of non-migrant Albanians increased by 0.6 percent. Strong positive effects were also found on wages of non-migrants, especially for low-skilled workers (between 2.5 and 5.9 percent increase).79 The job creation capacity of return migrants also generated significant GDP gains (between 0.8 and 1.3 percent of 2009 GDP). This mostly offset the negative effect caused by the reduction in remittances coming from Greece (1.5 percent of GDP). 71 Valette (2018), in a cross-country study of 20 OECD countries, shows that migrants transfer technology to their origin countries in the next five years after they have left their origin country, measured by increases in the economic complexity of their production. Fackler, Giesing and Laurentsyeva (2020) also find increases in patenting in 32 European origin countries due to emigration. 72 For example, Bahar and Rapoport (2018) find that a 10 percent increase in the migrant stock at destination is associated with a 2–3 percent increase in the likelihood that the host country starts exporting that good in the following decade. Docquier and Lodigiani (2010) find a long-run elasticity of the FDI to skilled migration of 50–75 percent. 73 OECD (2022). 74 World Bank World Development Indicators (2024). 75 Industries with 10 percent more returning refugees had larger exports between the pre- and postwar periods by 1.0 to 1.6 percent (Bahar et al. 2024). 76 Haxhikadrija (2009) and Möllers et al. (2017). 77 Hausmann and Nedelkoska (2018). 78 Hausmann and Nedelkoska (2018). 79 Ibid. Spotlight: Reaping the Benefits of a Global Workforce 75 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Emigration has reduced the supply of labor age population, particularly of those with less in all Western Balkans countries. During the employment opportunities, has helped reduce past two decades, rapid population outflows, the excess supply in the WB6 countries. However, combined with weak trends in the natural emigration can also lead to losses of human change of the population due to declining capital, particularly in the short term. Although fertility rates, have reduced the population emigrants tend to have similar or lower levels of in the WB6 countries. Between 2000 and education than the non-migrant population, the 2020, the population fell by 8 percent (10.7a), emigration of workers of all skill levels reduces equivalent to 1.2 million people. During the availability of skills in the countries of origin. this period, Bosnia and Herzegovina saw the In recent years skill shortages have become more largest population drop due to emigration (21 apparent in certain sectors. According to the 2021 percent of the population).80 As emigrants are Balkan Business Opinion Barometer, 44 percent disproportionately of prime working age, their of firms were unable to fill their vacancies with departure has significantly decreased the labor the needed skills, and 37 percent considered supply in the WB6 countries, amplifying the that these shortages were due to the emigration impact of emigration on the local workforce. of part of the workforce (Figure 10.7b). This is Emigration also reduces the supply of labor commonly observed across all countries in the through another indirect channel. The region. Skill shortages are found in sectors such increase in remittances leads to an income as ICT, engineering services, manufacturing, effect that increases reservation wages81 of and construction84. Skill shortages can generate household members in the countries of origin, distortions in firms’ composition of resources, and particularly women, dampening activity rates. limit productivity and growth. For the countries These patterns have been consistently observed of origin, it results in foregone consumption and in the Western Balkan countries.82 lower tax revenues. While these emigration outflows initially Of particular concern are shortages in some alleviated labor market pressures, they have key occupations, especially medical-related increasingly resulted in shortages across the jobs. While emigration of part of the workforce skills spectrum. In the past two decades, sizable occurs across different fields and education levels, emigration outflows from the WB6 countries concerns of a potential “brain drain” have been have coincided with significant reductions in particularly salient in specific sectors such as unemployment rates. In 2023, unemployment health care. During the past decade, the rate stood at 10.9 percent in the region, compared emigration of WB6 doctors has gained with above 20 percent of the active labor force momentum, with the stock residing in other during most part of the 2000s, with rates higher European countries more than quadrupling from than 30 percent in Bosnia and Herzegovina, 1,368 in 2010 to 5,752 in 2021.85 This represents Kosovo, and North Macedonia. This trend has 15 percent of the available medical workforce in been accompanied by improvements in the labor the Western Balkans, and more than 20 percent force participation rate –from around 55% in the in countries such as Albania and Kosovo.86 At the 2000s to close to 66% in 2023–, and a sizable same time, available data of graduates in medicine increase in wages.83 While there is no strong causal remains relatively stable in Montenegro, North evidence, the emigration of part of the working- Macedonia or Serbia.87 These patterns have led to 80 Population growth is calculated by the change between 2000 and 2020 divided by the population at the beginning of that period (2020). 81 The reservation wage is defined as the lowest level of wage at which a worker would be willing to accept a particular type of job. 82 Dermendzhieva (2009); Kalaj (2009); Rudi (2014) and Petreski (2019). 83 Around 105% in nominal terms between 2009 and 2022, and close to 35% in real terms according to ILOSTAT data. 84 OECD (2022) 85 OECD health workforce migration dataset. 86 Hashani et al. (2024). 87 Eurostat (2024) Health Graduates Database (hlth_rs_grd2). 76 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM FIGURE 10.7. Impact of emigration on the supply of labor and skills in Western Balkan countries a. Cumulative change in the WB6 population since 2000 b. Share of firms citing the following reasons for skills shortages 2 Applicants lack skills Labor force emigrated Change in population since2000 (%) 60 Percentage of firms 0 50 40 -2 30 -4 20 -6 10 Natural Change Net Migration 0 -8 Montenegro BiH Kosovo WB6 Albania Serbia Macedonia North Total Change -10 2000 2001 2002 2003 2005 2006 2008 2009 2010 2011 2012 2013 2015 2016 2018 2019 2020 2007 2017 2004 2014 Source: Bossavie, Garrote-Sanchez and Makovec (2024) “The Source: Western Balkans Business Opinion Barometer (2021). Journey Ahead: Supporting Successful Migration in Europe and Central Asia,” Europe and Central Asia Studies Series, Washington, DC: World Bank, based on UN DESA Population Division database. a more moderate increase in the rate of doctors In this context, foreign workers have per capita in the last decade, which remains increasingly been recruited to address significantly below that in the EU –ranging from labor shortages. Although WB6 countries around 300 doctors per 100,000 inhabitants in are historically emigration countries, there North Macedonia, Serbia and Montenegro, to has been a rapid increase in the inflows of 170 in Kosovo, compared to 400 in the EU–.88 immigrants in the past decade. In 2020, more Two-thirds of WB6 migrant doctors reside in than 1.1 million foreign-born individuals Germany alone. More broadly, Germany has resided in the Western Balkans (6 percent of attracted more than 18,000 WB6 health-care the population), 0.8 million in Serbia alone. workers since the implementation of the Western However, close to 90 percent are from other Balkan regulation in 2015.89 From the perspective former Yugoslavian countries with long-term of Western Balkan countries, this represents a loss residency since the redrawing of borders and of human capital, although it also coincides with subsequent wars. In the past decade, inflows still significant although declining unemployment of immigrants have accelerated, mostly driven rates of health-care professionals. Given the low by economic reasons due to the increasing supply of doctors in the region and the increasing demand in the Western Balkans to fill labor demand in the coming years due to aging, more shortages. In Serbia, 155,000 immigrants have investments in the health-care system would arrived since 2011, and two-thirds are from require additional workforce in the medical non-Balkan countries. The annual issuance sector.90 of work visas rose from 2,512 in 2010 to 13,475 in 2021, with the largest nationality groups being China, Türkiye and India.91 Similar trends are observed in other countries. In Montenegro, the number of immigrants 88 Healthcare personnel statistics for 2021, Eurostat (2024). 89 Mara (2023) “Health Professionals Wanted: The Case of Health Professionals from Western Balkan Countries to Europe.” and Schmitz-Pranghe Oruč, Mielke and Ibričević (2020). 90 European Training Foundation (2021). 91 Ministry of Interior of the Republic of Serbia (2022): https://kirs.gov.rs/media/uploads/Migracije/Publikacije/Eng/Migration%20Pro- file%20of%20the%20Republic%20of%20Serbia%20for%202021.pdf Spotlight: Reaping the Benefits of a Global Workforce 77 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 has tripled, from 1,741 in 2015 to 15,989 in incentivize human capital accumulation in 2022.92 In Bosnia and Herzegovina, annual origin countries. In the Philippines, evidence work permits for immigrants increased from shows that more migration pathways for 2,593 in 2017 to 3,780 in 2022, driven by nurses in the United States led to an even faster increases of immigrants from South Asia and increase in enrolment and graduation of nurses Türkiye.93 In Albania, Kosovo and North in the country. For each nurse that emigrated, Macedonia, inflows of immigrants have nine new nurses were licensed, leading to more remained more limited although they are also human capital accumulation in the country.95 growing.94 Additionally, recent developments since Russia’s invasion of Ukraine have led In some Western Balkans countries, initial to a significant increase in the number of evidence suggests that this positive effect Ukrainian refugees in the Western Balkans might also be at play. Households receiving (around 92,000 in 2023, of which two-thirds remittances spend part of them on education, of them are in Montenegro). which in some cases can support better education outcomes for children.96 There is In the longer term, there is increasing also evidence of human capital accumulation evidence that emigration does not of migrants themselves during their migration necessarily lead to human capital losses experience, with close to 9,000 WB6 emigrant if the right incentives are in place. students in Europe in 2022.97 Surveys of Emigration can become a source of human return migrants in Albania also find that skills capital accumulation through different acquisition while abroad leads to upward channels. First, remittances sent by emigrants occupational mobility and productivity increase the availability of financial resources enhancements in the country.98 In Kosovo, in emigrant households, which can spend the Heimerer College aims to improve the part of them on the education of family availability of skills in the country’s health-care members who do not migrate. Second, the sector with curricula and qualifications aligned return of high-skilled migrants may also with and recognized by the German labor represent a “brain gain” opportunity for the market99. While Heimerer College’s graduates country. Emigrants themselves often acquire have skills and qualifications that could help new educational degrees and skills overseas, them find jobs in Germany, data show that which positively revert to the country when only 20 percent of those who are employed they return. Third, the prospects of higher have moved abroad (see Box 10.3). wages abroad in specific sectors can further 92 In Albania, the stock of immigrants with work permits increased by more than 2,000 between 2015 and 2022 (Instat, 2024), while in Koso- vo and North Macedonia it increased by more than 700 workers during the same period (Eurostat, 2024 and Kosovo Government Authority for Migration, 2024). 93 Bosnia and Herzegovina’s Ministry of Security (2022). 94 Eurostat statistics on immigration [migr_imm1ctz] and Kosovo Government Authority on Migration (2024). 95 Abarcar and Theoharides (2024). 96 For example, studies in Kosovo (USAID 2010) or Bosnia and Herzegovina (Oruc, Jackson and Pugh 2018) find that migrant households not only allocate part of remittances to education, but they also spend more overall on education than non-migrant households. In Bosnia and Herzegovina, it translates into better educational enrolment in certain low to middle quintiles of the population. 97 Eurostat (2024). 98 Bucheli and Fontenla (2022); Bahar et al. (2019); Kilic and Carletto (2009). 99 OECD (2022). 78 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM Box 10.3: The Heimerer College in Kosovo The Heimerer College is a private university in Kosovo that provides training opportunities in the health-care sector following the curricula and the qualification system adopted in Germany. The college offers a variety of undergraduate and postgraduate degree programs, including in fields and specializations not commonly offered in the Western Balkans. These programs also include on-the-job training opportunity in Germany. The college was founded by a diaspora investor and is privately funded through student tuition fees.100 The program has been successful at providing opportunities for 1,802 students between 2013 and 2023, with 93 percent of students graduating between 2013 and 2023 being employed, 80 percent of them in Kosovo101. Through its programs, this model of bilateral labor and training agreement with Germany has increased human capital in the health sector in Kosovo,102 and built health-care vocational training capacity, aligning it with international standards. It has also created both supply and demand for new health specialties such as autism services that previously did not exist in Kosovo103. Overall, it is a successful example of how bilateral agreements can facilitate formal migration pathways while expanding the availability and variety of human capital in the country. 100 German employers fund language courses for those who access the migration track. 101 Beqiri (2024). 102 According to health statistics from the Kosovo Agency of Statistics, the number of nurses certified by the Chamber of Nurses has increased from around 12,000 in 2018 to over 30,000 in 2022. 103 OECD (2022). However, migration still has an untapped their diaspora for developmental purposes. potential in the Western Balkan region, as Even in countries with more active diaspora some beneficial channels are still not fully engagement programs such as Bosnia and active. Remittances, while providing a vital Herzegovina, there is a large untapped potential income to migrant households, still have limited for the economy, as only a small fraction of developmental impact. The cost of remittances those interested in investing in the country end through formal channels in the Western Balkans up doing so.106 There is also significant room for remains high, ranging from 4.3 to 10 percent maximizing the earnings potentials of migrants depending on the migration corridor; and this throughout the whole migration journey. The cost exceeds the SDG target of 3 percent.104 large prevalence of occupational downgrade of Notably, remittances sent between WB6 WB6 migrants in Europe reduces the potential countries are 32 percent costlier than those sent gains from the migration experience and limits the from other parts of the world to the region. These diversity of skills acquired. This skill waste reduces costs reduce the incentives of immigrants to send the beneficial impact of migration for migrants, money back. Furthermore, remittances are rarely origin and destination countries alike, and channeled toward productive investments and hampers productivity. The limited recognition entrepreneurship.105 Western Balkan countries of education credentials and certificates in many can also expand their outreach efforts to engage of the main destination countries is usually the 104 World Bank Remittance Prices Worldwide database https://remittanceprices.worldbank.org/. 105 World Bank (2022). 106 One in three migrants want to invest in the country, but only 6 percent do so (Efendic, 2021; Williams, 2019). Spotlight: Reaping the Benefits of a Global Workforce 79 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 reason why migrants do not work in the field or specific bilateral social security agreements are in level of occupation that they are trained in.107 place, the portability of pensions is also limited. The migration decision is based on a perceived In addition, some emigrants are still exposed cost-benefit analysis of the journey. Some to different types of vulnerabilities while emigrants, particularly low-skilled ones, have embarking on their journeys and during their unrealistic expectations regarding the employment stay abroad. While migration can boost lifelong opportunities abroad, and the availability of earnings of emigrants and their households, this formal migration channels. An example of this journey is not exempted from risks. Evidence was seen by the rapid spike in asylum applications shows that migrants are more responsive to to the EU of West Balkans migrants, from labor demand conditions than non-migrants, 53,000 in 2013 to 170,000 in 2015, led by showing higher rates of job destruction during misinformation on asylum requirements. This downturns.108 That was the case of WB6 emigrants resulted in massive rejections of asylum applicants, in the EU during the COVID-19 pandemic, who were forced to return unexpectedly to the who suffered higher job losses than the average Western Balkans. More broadly, return migrants, population.109 This pattern is due to factors such mainly those whose migration journey was as the higher concentration of immigrants in a few unexpectedly interrupted, face additional barriers sectors or lower tenure and formality of employment to reintegrating in the domestic labor market,110 contracts. Moreover, immigrants are less likely to ranging from bureaucratic hurdles, loss of local have access to social insurance mechanisms— networks and knowledge, cultural adaptation or, either in the host country or at home—reducing in some cases, stigma or discrimination. their ability to cope with income shocks. Unless Migration systems and policies in the WB6 countries: the status quo Recognizing the importance of migration, specific inter-ministerial bodies to facilitate WB6 countries have developed strategies, coordination. In recent years, WB6 countries laws, regulations, and institutions to harness have also taken important steps to develop a the benefits of migration. All countries have common intra-regional market and increased adopted migration strategies. These documents the regional coordination on migration with tend to focus on improving the management the EU.112 of migration flows and support the integration of return migrants. All WB6 countries with Agreements with some destination countries the exception of Bosnia and Herzegovina also were introduced over the years to ensure the have strategies to engage their diaspora.111 In safe migration and employment of workers. line with the different goals and objectives, One of the most comprehensive bilateral labor governments in the region have strengthened agreements was signed between Bosnia and the legal framework on migration, progressively Herzegovina and Slovenia in 2011 to limit aligning it with EU standards. All countries have informal migration flows. Annual quotas of competent institutions in charge of different migrants were established, and employment aspects of the migration system and have created agencies were set up to cooperate throughout 107 Western Balkan countries are making efforts to align their national qualification frameworks to the European Qualifications Framework (EQF) to facilitate the interpretation of a qualification and its level in EU destination countries. 108 Azlor et al. (2020). 109 Bossavie et al. (2021). 110 Migrants who are forced to return unexpectedly tend to accumulate lower levels of savings or international experience compared to what they had planned, which then hinder their ability to successfully access job opportunities or start their own businesses in their home country. For example, the Albania Return Migration Survey (2013) shows that those that planned their return were 20pp more likely to be employed than those that were forced to return (65.7% vs 45%). 111 Bosnia and Herzegovina has passed the Policy for Cooperation with the Diaspora that aimed to pave the way to a diaspora strategy yet to be approved. However, both the Federation of Bosnia and Herzegovina and the Republika Srpska have in place their own diaspora strategies. 112 Through the Migration, Asylum, Refugees Regional Initiative (MARRI). 80 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM the migration process, from the selection stage for their migration journeys by providing to the return. Both countries also exchange information on in-demand occupations and data to ensure insurance payments to migrants requirements, and regulations in key destination are made depending on where they work and countries.116 While abroad, emigrants from all reside.113 Several WB6 countries also have WB6 countries can access consular services, and bilateral cooperation with Germany on skills benefit from the portability of social security in training and migration agreements in specific countries where bilateral agreements are in place. sectors.114 Migration regulations in destination WB6 countries have also developed different countries have also shaped migration flows. initiatives to map and engage the diaspora and In particular, the Western Balkan Regulation increase its developmental impact. These include (WBR) in Germany has opened legal pathways online platforms and registries,117 knowledge- for WB6 migrants with all skill levels to emigrate sharing events,118 and services and incentives to if they have a job offer.115 spur diaspora investments in the country (See Box 10.4 for an example of a diaspora project With a certain degree of variation, some in Bosnia and Herzegovina).119 WB6 countries services have also been introduced to help have also expanded services for returned migrants WB6 emigrants throughout their migration under readmission agreements to support their journey. Cognizant of the fundamental role of repatriation and reintegration. In recent years, migration, WB6 countries have increased service some initiatives have emerged to incentivize the provision to migrants in recent years. These range return of highly skilled migrants.120 from information on migration opportunities for prospective migrants, to support services targeted However, challenges in six main areas remain to the diaspora, to repatriation and reintegration with implications on the effectiveness of the support for returning migrants. The availability of initiatives introduced by Western Balkan services varies across WB6 countries and is shaped governments. These challenges include: (i) by the degree of collaboration and development limited cohesiveness of policy frameworks and of bilateral agreements with third countries. imperfect coordination between stakeholders; Before departure, the bilateral labor agreement (ii) inadequate provision of tailored services between Bosnia and Herzegovina, and Slovenia to emigrants; (iii) underdeveloped systems to offers an example of how public employment manage inflow of foreign workers; (iv) capacity services (PES) in both countries can cooperate constraints (including financial, IT, and to make employment opportunities in Slovenia human resources); (v) complex bureaucratic accessible for workers in Bosnia and Herzegovina. processes, including the issuance of relevant The employment agencies of Albania and migration-related documents for emigrants Kosovo support prospective migrants to prepare and returnees; and (vi) data gaps. 113 Ministry of Civil Affairs of Bosnia and Herzegovina and Ministry of Labor, Family and Social Affairs of the Republic of Slovenia (2011); https://www.ess.gov.si/en/jobseekers/employment-of-non-eu-migrant-workers/work-in-slovenia/employment-of-nationals-of-bih 114 For example, the “Triple Win” program between Germany and Bosnia and Herzegovina in the nursing sector. 115 In its initial phase (2016–20), the WBR provided 244,000 preliminary approvals of employment, and was extended indefinitely in 2023 (Brücker et al., 2020). 116 https://akpa.gov.al/informacione-rreth-emigracionit/. In Kosovo, the EARK is also working on the certification of prior learning in specific occupations like welding to be recognized in Germany (ETF, 2021). 117 Most countries have developed online platforms and registries of individuals, associations, and businesses to map and engage their diasporas worldwide, with initiatives led by the government (e.g., ediaspora.rks-gov.net from the Kosovo Government) and private sector (e.g., “i-di- jaspora” in Bosnia and Herzegovina). 118 The Ulpiana forum in Kosovo or Macedonia 2025 in North Macedonia are examples of diaspora fora. The Serbian Science Fund provides financial incentives for diaspora members to develop research projects in the country in collaboration with domestic research centers, incen- tivizing cross-national research and innovation. 119 Other examples of support for diaspora investors include the MARDI project in Kosovo, or the initiative by the chamber of commerce in North Macedonia to create business centers for the diaspora. The government of Kosovo also issued diaspora bonds in 2021 to attract more capital to the economy, raising EUR 10 million out of the targeted EUR 20 million. 120 For example, the project Returning Point in Serbia identifies key barriers migrants face, promotes successful return stories, and assists return- ees by providing relevant information and creating networks. Spotlight: Reaping the Benefits of a Global Workforce 81 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Box 10.4: The Diaspora Invest Project in Bosnia and Herzegovina The Diaspora Invest Project in Bosnia and Herzegovina is one of the largest projects in the Western Balkans to leverage diaspora investments for economic development. It was launched in 2017 with a budget of US$6.6 million funded by the United States Agency for International Development (USAID). The project provided a complete package of support to diaspora investors including: (i) grants to diaspora firms to incentivize investment; (ii) technical assistance to firms to start or expand a business; and (iii) an information exchange platform to facilitate international networks. The project focused on strengthening links between the diaspora and local communities of origin and the capacity of municipalities. Municipalities provided further incentives to invest, such as local tax exemptions, free land in economic zones, financial support, or one-stop shops for businesses. Over four years of the first phase, US$2 million in grants were distributed to 164 beneficiary companies, which invested more than US$22 million of their own funds. Beneficiary firms increased their sales by over 70 percent, mostly toward exports in countries where diaspora owners resided. In the labor market, diaspora firms generated 1,571 new jobs in the local economy. Beneficiary firms were spread out across the country, as diaspora investors prioritized investing in their localities of origin rather than main economic centers. In 2022, the program started a second five-year phase, with a budget of US$15.7 million. Despite substantial improvements in the better set adequate policies and serve them governance framework, migration systems and, when they do, they are not always in the Western Balkans have room to expand embedded and consulted in the policy process. their cohesiveness and coordination across actors. Most WB6 countries can enhance the Migration systems in all WB6 countries developmental aspects of migration in their have gaps in the service provision to long-term vision and strengthen the emigrants throughout their migration intertemporal migration policy cohesiveness. journey. Prior to departure, only a few In some cases, countries could further clarify countries offer information on employment objectives in their migration agenda, set opportunities abroad. Access to skill training concrete action plans, and develop monitoring programs for migrants is also limited. While and evaluation systems to assess their progress. residing abroad, WB6 emigrants still do not While all countries have institutions in place have adequate access to social insurance or full to support the different aspects of migration, portability of pensions in many destination in some cases they would benefit from more countries. In emergency situations, as during clarity on their different roles and the COVID-19 pandemic, rapid support responsibilities. Coordination mechanisms services remain limited. Services provided by exist, but their implementation is ad hoc. WB6 countries to engage their diaspora also Coordination is particularly challenging tend to be fragmented and donor-driven. In between institutions at different administrative many cases, insufficient outreach of diaspora levels. This is important as, while migration programs and a lack of trust in institutions policy is decided at the central level, most have limited the usage of these services by migrants and returnees interact and receive most migrants. Most WB6 countries also services from local institutions. Few WB6 lack incentive packages to promote and countries have created diaspora councils to facilitate the return of migrants, including tax 82 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM incentives, information on job opportunities in and verification about the skills of foreign the home country, or other forms of financial workers, leading to potential skill mismatches. assistance. For return migrants, services are There are also limited pre-departure support more developed, although important gaps and integration measures for foreign workers remain. First, they focus on migrants under in WB6 countries. Overall, WB6 countries readmission agreements, while voluntary rank among the lowest in terms of integration returnees do not usually access any of these policy measures across Europe123. services. Second, there are limited outreach efforts, leading to low utilization. WB6 Complexities in bureaucratic processes also countries are in different stages of development generate barriers that hamper emigrants’ of the case management system for returnees access to services. Countries have room but, generally, services are still fragmented and to improve and streamline bureaucratic need to be strengthened.121 procedures that have an impact on emigrants. For example, banking regulations can limit the The management of foreign worker inflows capacity of emigrants to have bank accounts in WB6 countries is also becoming a in different currencies and delay transfers of topic of important attention. Most WB6 money across countries. This can disincentivize countries have included objectives and specific the diaspora to invest in the country, or the interventions in their migration strategies return of some of them. Recently, Albania has to manage immigration inflows and curb made efforts to facilitate the transferability irregular migration into the country. These of financial assets and ease the burden of countries also have measures to support bureaucratic requirements.124 Migrants also the integration of immigrants, although face bureaucratic challenges in transferring and implementation budgets tend to be limited. translating personal records across countries, Albania, Kosovo, North Macedonia and which can be costly and lengthy. Also, Serbia also aim to attract skilled immigrants additional administrative requirements such to address labor shortages in their migration as historical medical records can de-facto limit strategies. One key issue throughout all WB6 their registration and access to certain services countries is the lengthy process to obtain work back in their country of origin. Recognition permits and visas, which involves many actors of skill credentials obtained in third countries and raises coordination challenges122.This is another key barrier that return migrants pushes employers to seek private recruitment face in re-integrating into the labor market. and employment agencies to help navigate WB6 countries are also at different stages in the system, putting at the forefront the need implementing their national qualifications to better regulate these agencies and the frameworks and aligning them with the EU recruitment process. WB6 countries have Directive 2005/36/EC on recognition of not signed bilateral labor agreements (BLA) professional qualifications.125 with potential countries of origin of foreign workers to facilitate formal migration flows. Capacity constraints hinder the ability WB6 countries also have limited linkages of government institutions to implement between their immigration policies and migration policies and support migrants their labor market needs. For example, the throughout their journey. In all WB6 selection process lacks accurate information countries, governments have mobilized sizable budgets for implementing their migration 121 As shown by satisfaction surveys to return migrant beneficiaries (World Bank, 2024). 122 IOM (2024) 123 MIPEX Index (2024) 124 Gedeshi, I. (2021): “How migration, human capital and the labour market interact in Albania,” ETF, Turin. 125 Mara, I., and M. Landesmann (2022): “‘Use It or Lose It!’ How Do Migration, Human Capital and the Labour Market Interact in the Western Balkans.” ETF. Spotlight: Reaping the Benefits of a Global Workforce 83 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 strategies126. However, some of them rely for migrants who are forced to return under heavily on donor funding, which can be more readmission agreements. Diaspora registries volatile. Moreover, resources—both financial and censuses have so far achieved only limited and human—are mostly concentrated on success, hindered by limited outreach and border control. On the other hand, the capacity incentives for the diaspora to participate. to support the developmental potential of Periodic surveys in WB6 countries also have the diaspora is more limited. Institutions insufficient coverage of current emigrants in charge of diaspora engagement tend to and returnees and ad-hoc migration surveys be understaffed, hindering their capacity are scarce.127 As a result, there is imperfect to connect and provide valuable services to knowledge of the size of the WB6 mobile their citizens residing abroad. Despite recent population, its profile and migration patterns, investments, authorities supporting returnees or of outcomes both in destination countries under readmission agreements, particularly and upon return. Significant data gaps also those at the local level, have limited human exist on the profile and skills of the foreign- resources and have training needs. Resources born population, given the limited depth are even more limited to support the of information collected in administrative reintegration of migrants who voluntarily sources and the challenges of regular surveys return. At the municipal level, insufficient to capture this still relatively small and mobile human resources for monitoring and population. Beyond data collection, there are evaluation can also compound the data and also challenges in the standardization of data coordination challenges previously mentioned. and the interoperability of systems. This limits There is also limited interoperability of systems the exchange of information and collaboration across institutions, hindering service delivery between institutions with responsibilities on to migrants. migration. These data gaps hamper the ability of WB6 governments to understand the Data gaps limit the capacity of WB6 linkages between migration and local skills and countries to implement evidence-based labor markets, to implement well-informed migration policies. As in other origin evidence-based policies, and to test what countries, current data availability on interventions work best and have the potential migration is incomplete and fragmented. to be scaled up and what interventions are not Registration of emigrants and return migrants effective or even harmful. is mostly limited to self-reporting, except The way forward: reaping the benefits from a global workforce Reaping the benefits from migration in the remain physically outside the country, this Western Balkans requires a change in global workforce can significantly contribute mindset. The existing efforts in the WB6 are to the country’s development in various ways, not sufficient to fully unlock the benefits of such as bringing essential flows of capital and migration. The human capital and the expertise to the local economies or building workforce available to the WB6 countries are economic linkages with other countries (e.g., not only that of the people who currently live trade and business networks). Additionally, within their borders but also includes their with lower barriers to mobility due to changes global workforce. A portion of this population in regulations in some EU member states, eventually returns to their home countries stronger cooperation between the WB6 and while others remain abroad. Even when they migrant-destination countries is needed. The 126 OECD (2022) 127 The 2019 National Household Migration Survey in Albania is the latest survey collected in the region. 84 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM following paragraphs, summarized in Table could enhance the benefits of migration for the 10.1, present a snapshot of interventions that development of the Western Balkan economies. TABLE 10.1. Recommendations Policy recommendation Responsible institution(s) I. Strengthening the migration governance framework Applying a migration lens to different national strategic documents Ministry of Finance, Ministry of Economy, Ministry of Labor, Ministry of Education and other line ministries Developing skills training and mobility programs (e.g., Global Skills Ministry of Labor, Ministry of External Partnerships) Affairs Expanding the depth and breadth of Bilateral Labor and Social Security Ministry of External Affairs, Ministry of Agreements (BSSA) Labor, Public Employment Agency II. Expanding protection and service provision to emigrants throughout their migration journey Improving social protection to emigrants Diaspora Agency, Ministry of Labor, Ministry of Social Welfare Providing pre-departure information and training for prospective Public Employment Agency,Ministry of emigrants Education, Ministry of Labor Strengthening consular services for emigrants Ministry of External Affairs, Embassies Reducing the cost of remittances Central banks, Ministry of Finance Expanding outreach efforts to map the diaspora Diaspora Agency, Ministry of External Affairs, Embassies Strengthening and scaling up diaspora investments and knowledge- Diaspora Agency, Ministry of External sharing programs Affairs, Embassies Providing information and tax incentives to support the return of Ministry of External Affairs, Embassies, migrants Ministry of Finance, Public Employment Agency Expanding support services to return migrants in need to facilitate Public Employment Agency, Ministry of their reintegration Interior, Ministry of Labor, Ministry of Social Welfare III. Developing a fit-for-purpose immigration system Investing in labor skills monitoring systems and linkages to migration Ministry of Labor, Public Employment policy Agency, Ministry of Interior Providing services to foreign workers to facilitate their integration in Public Employment Agency, local the labor market governments, Ministry of Social Welfare IV. Leveraging technology and data to increase the effectiveness of services Digitalization to support an integrated migration management and Ministry of Interior, Public Employment service delivery systems Agency, municipalities Strengthening data collection by establishing a comprehensive registry National Statistics Agency, Diaspora covering short- and long-term migration Agency, Public Employment Agency, different ministries with roles on migration Spotlight: Reaping the Benefits of a Global Workforce 85 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 I. Strengthening the migration governance framework To implement this shift in mindset, the first world, including in the region.129 EU countries step is to apply a migration lens to WB6’s are increasingly interested in these types of national development strategies. This entails models that fit within the Talent Partnership connecting migration policies throughout the (TP) framework announced in the recent EU migration cycle to the development objectives Pact on Migration and Asylum. The final goal of the country and consolidating its different is to explore mutually beneficial labor mobility elements into a singular legislation. Initial and skills arrangements between the EU and steps in this direction have been made in partner countries. TPs incorporate capacity several WB6 countries. For example, Albania building in partner countries, including in has included key components of the migration vocational education and training, and support agenda under the country’s main strategy, for nationals of those countries to be trained the “National Strategy on Development and and work in the EU.130 Integration”. WB6 countries could also explore further Global Skills Partnerships (GSPs) are expanding and developing the depth examples of programs that can increase of bilateral and multilateral labor and the development impacts of migration for social security agreements with main Western Balkan countries. These programs destination countries. These are essential are bilateral labor and training agreements for enhancing coordination across countries between two countries. Through these in the matter, strengthening formal labor arrangements, workers in the country of origin migration corridors and reducing irregular are trained in skills that are in demand in migration, and better protecting and serving both countries, with the destination country mobile workers throughout their migration participating in the funding and development journey. Western Balkan countries can build of the curriculum. After the training, some on existing examples, such as the Bosnia and trainees emigrate to work in the destination Herzegovina and Slovenia bilateral labor country (“abroad” track), while others remain agreement (BLA), to expand the coordination and work in their country of origin (“domestic” with third countries. Data-sharing of relevant track). The two tracks ensure that both countries information for migrants is a key element that are able to benefit from the development of needs to be included in agreements with the skills. These programs also address concerns main destination countries. of human capital losses in sending countries due to emigration, while providing additional formal migration pathways for migrants in specific sectors. Furthermore, GSPs strengthen the capacity of education and training systems in the origin countries, and align them to international standards.128 GSPs provide a holistic skill and migration package that includes tailored services and support to prospective migrants, and ease coordination challenges across actors in both countries. Pilots have already been developed across the 128 Adhikari et al. (2021). 129 Center for Global Development (2021). 130 European Commission (n.d.). 86 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM II. Expanding protection and service provision to emigrants throughout their migration journey An internationally mobile workforce also abroad, emigrants can benefit from stronger requires the development and adaptation consular sections that provide counseling and of social protection instruments to mitigate support. WB6 countries could also consider the risks that they may face. Many migrants measures to reduce the cost of remittances, from the Western Balkans are still not fully such as exempting remittance flows from fees, covered by social protection systems, neither improving the competitive environment in the in origin nor in destination countries. The remittance market, and supporting technology proposed expansion of BLAs and BSSAs can adoption in payment and settlement better cover migrants against risks and facilitate systems.133 Evidence from other regions shows the portability of pensions and unemployment that the reduction in the cost of remittances benefits. International evidence shows that this promotes their transfer through the formal not only increases migrants’ welfare but also financial system.134 To incentivize return incentivizes some of them to return to their migration, governments have room to ease the home country.131 A particular focus should repatriation of funds, including reducing the also be given to increasing the protection tax burden, especially that of double taxation. of migrants with informal employment The current system of service delivery for contracts. WB6 countries can consider return migrants under readmission agreements developing welfare funds to provide financial could be expanded to provide tailored services assistance to migrants facing adverse economic to more successful returnees, such as access situations, similar to the situation that many to networks and support for entrepreneurial faced during the COVID-19 pandemic. activities. For example, the Overseas Welfare Fund of the Philippines provides support to migrant More broadly, WB6 countries have a unique workers irrespective of their working status.132 opportunity to strengthen the engagement Welfare funds can be financed by personal with the diaspora through a more holistic contributions and/or through the engagement approach to expand their development of private employers. impact. In previous decades, individual diaspora programs in the Western Balkans have Government agencies can also expand their shown promising results and the potential the services to their mobile population across diaspora has to support the local economies, borders. As workers move between countries, even without returning. Moving forward, their demand for services evolves. Before expanding the role of the diaspora requires departure, Western Balkan public employment institutionalizing current engagements under agencies can expand migration information a long-term comprehensive approach that services and skills training provision to increase addresses the main challenges that the diaspora the readiness of prospective migrants and to faces to give back to the local economy. This ensure more equitable access to migration starts with investing in extensive outreach opportunities. For example, employment efforts to map the diaspora, strengthening agencies can share job offers so migrants trust in public institutions, and enhancing can have better information at home on migrants’ connection to their home country opportunities in destination countries. While through service provision and cultural identity 131 Avato, Koettl, and Sabates-Wheeler (2010). 132 ILO (2023): “Using Migrant Welfare Funds as a social protection instrument – potential and limitations?” Social Protection Spotlight. 133 World Bank (2006): “Reducing Remittances Fees”, Global Economic Prospects. 134 Ambler et al. (2014); Aycinena et al. (2010). Spotlight: Reaping the Benefits of a Global Workforce 87 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 events, or promotion of political rights. information, financial support, training) into Ireland is a successful example of a country one-stop shops that are easily accessible to that developed a comprehensive system to diaspora investors. Furthermore, more efforts leverage its diaspora’s resources to support its can be made to expand the matching between economic growth (see Box 10.5). Best practices the diaspora and the local economy, be they include consolidating support services (e.g., entrepreneurs or research centers. Box 10.5: Diaspora engagement in Ireland Similar to many Western Balkan countries today, Ireland is a small country that faced sizable waves of emigration throughout the 1900s and 2000s.135 However, robust economic growth in the final decades of the twentieth century led to a reversal of trends, and the country now attracts more inflows of migrants, including the return of Irish emigrants. The dynamism in the economy supported growth in wages over a prolonged period of time, reducing earning gaps with main destination countries (e.g., the United States or the United Kingdom). As the economic growth increased employment opportunities, Ireland took purposeful steps to connect and attract its sizable diaspora. Ireland’s diaspora engagement is based on a vision of the ‘Global Irish’ workforce where the diaspora can contribute in different ways whether they return or not. All the engagement is guided by the overarching diaspora strategy (‘Global Ireland’ 2020–25) that connects individual programs and links all the main objectives to the development strategy. The Government of Ireland offers a wide range of services, from providing assistance while abroad, to maintaining connections to the country through cultural events, to promoting return and entrepreneurship back home. To improve the success of these programs, the Government has invested in building trust and a common Irish identity through philanthropic and cultural events. These efforts have led to larger flows of diaspora resources in the economy, such as FDI, tourism, and global networks. Another important lesson from the Irish case is that the continued investment in the education system, even if it initially meant that more high-skilled individuals were emigrating, had positive payoffs decades later. As a powerful example, the return of high- skilled migrants that accumulated wealth, knowledge and global networks while abroad was a key engine in the development of the IT industry in Ireland, which proved to be vital for growth. 135 Barrett (2005). 88 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM III. Developing a fit-for-purpose immigration system WB6 countries can strengthen their the main skill gaps and in what sectors so they immigration systems to better select, train, can be addressed, either through educational and integrate foreign workers to ensure the investments, inflows of return migrants, or availability of needed skills in the labor import of immigrant workers. More efforts market. Bilateral employment and social to streamline the selection process of foreign security agreements need to be developed workers are needed to be more reactive to labor with potential countries of origin of foreign market needs, including reducing timelines for workers to better regulate entry paths and visa and permit applications, and eliminating enhance the protection of immigrants duplicate steps required by different agencies. (including portability of benefits and In order to facilitate the social inclusion and regulating recruitment agencies at origin and integration of foreign workers, WB6 countries destination). Linking immigration to labor can also expand services to this population, market needs will also require better forward- including language training, better access to looking skills monitoring, including what active labor market programs, and enhancing skills will be more in demand and what are rights for family members. IV. Leveraging technology and data to improve the effectiveness of services Digitalization can support the streamlining at border crossing points and in their home of bureaucratic procedures and facilitate municipalities through the Municipal Office coordination across multiple stakeholders. for Communities and Return.137 This model Digitalization of different procedures can can be expanded beyond return migrants ease some capacity constraints, and support under readmission agreements to cover a more effective and integrated migration broader group of emigrants and throughout management and service delivery systems. the different phases of migration, as well as This, in turn, facilitates the coordination of foreign workers arriving to the country. migration policy across different agencies. It also allows the implementation of the Strengthening data is imperative to electronic Case Management System that can better inform migration policymaking. support migrants in a holistic way throughout A comprehensive registry of migrants that their migration journey. In the region, Kosovo covers short- and long-term migrants, and also has developed a good example of electronic captures their return to the country, is needed case management for return migrants that as a base for building effective policies and covers the entire process of reintegration, service delivery. To do this, incentives should be from the return to the settlement in different created for migrants to register, including the municipalities.136 The electronic system can provision of valuable services. Key information be accessed by all relevant public agencies on migrants for sound policymaking includes and contains relevant information on services their migration patterns, education, skills, provided to migrants and different outcomes and work experience. Censuses and periodic of interest. Services provided include nationally representative surveys can also temporary shelter, transportation, medical incorporate questions to capture both current services, or information. Needs assessments migrants and return migrants to be able to and referrals are done both in reception centers assess their socio-economic outcomes. In 136 Republic of Kosovo (2017). 137 Republic of Kosovo (2020). Spotlight: Reaping the Benefits of a Global Workforce 89 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 addition, the WB6 countries can consider Survey. As data collection efforts increase, it is developing ad-hoc migration surveys with important to use an evidence-based approach detailed questions on the migration history, in migration policymaking. This includes skills, constraints and vulnerabilities, and developing rigorous evaluations of different outcomes in the education and labor markets migration programs. Given the uncertainty throughout the migration cycle, before about the effectiveness of many ongoing migration, while abroad, and after returning interventions, learning is critical to calibrate to the home country. Recent examples of such and adjust, scaling up the more successful surveys include the 2023 Kyrgyz Migration ones while discontinuing those showing worse Survey or the 2019 Bangladesh Return Migrant results to avoid misguided policies. Conclusions Overall, Western Balkan countries are the benefit of migrants and local economies at an important juncture, with a unique alike. Time is of the essence in addressing the opportunity to better leverage the role existing challenges. From the perspective of of migration to enhance economic the emigrant population, the large diasporas development. With some of the largest can still be engaged and supported via multiple diasporas around the world as a share of the channels to participate in countries’ economic population, migration has been part of the development. From the perspective of foreign- region’s identity for decades. Reflecting on born workers, recent trends have shown that this, the WB6 countries have made substantial immigration will continue growing to fill progress in developing their migration important workforce gaps. As such, the WB6 systems. Despite these efforts, relevant gaps countries can take action to further develop remain. This spotlight provides several options their systems to select, train, and integrate for policies that can support a more holistic foreign workers in their economies and, more and development-centric approach to support broadly, in their societies. the Western Balkans mobile population for 90 Spotlight: Reaping the Benefits of a Global Workforce WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Country Notes 92 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM Albania • Growth in 2024 is expected to remain robust at 3.3 percent, on the back of private consumption, tourism, and construction. Price pressures have continued to ease. • Poverty is expected to continue to decline as labor income increases. • Medium-term prospects hinge on the recovery of the global economy and on the pace of structural reforms. The EU accession aspirations provide an anchor to speed up convergence. Key conditions and challenges Recent developments The Albanian economy has shown considerable Following a 3.4 percent real growth rate in resilience as prudent macroeconomic policies 2023, Albania’s economy grew at a higher pace supported a strong economic rebound, with real of 3.6 percent in Q1 of 2024. On the supply GDP growth averaging 4.2 percent in 2022 and side, growth was primarily driven by services 2023. A key factor in Albania’s resilience has been and construction. Private consumption the proximity to the EU, a key source of investment and investment were the main drivers on and remittances, and a main destination for exports. the demand side. In the coming quarters, Tourism remains a key growth driver, helping investment and services exports are expected to improve external imbalances and partially to strengthen. Economic sentiment remains contributing to a steady appreciation of the LEK in positive, though showing signs of moderation. recent years. The availability of hydropower, which At the end-2023, the employment rate meets 85 percent of domestic energy demand in reached 66.7 percent with variation across years with average precipitation, has contributed to demographics, with a 0.7 percentage point containing the country’s greenhouse gas emissions. increase for men and 0.3 percentage point Albania’s key development challenges are its decrease for women. Overall, poverty declined declining population, partially due to outmigration; by 1.9 percentage points to reach 21.7 percent. the poor quality of the labor force and the low Based on administrative data for Q1 2024, quality of jobs created; the moderate pace of employment grew by 1.1 percent y-o-y, driven structural reforms, especially in the areas of private by the private sector. The average private sector sector environment and governance; and rising fiscal wage increased by 12.7 percent, reflecting pressures, due to climate risks, contingent liabilities growth across all economic activities. Annual and debt refinancing at a time of the high cost of inflation rate continued its declining trend, external financing. To create the needed fiscal space averaging around 2.7 percent in Q1 of 2024, and address these challenges, Albania will need to as a result of downward pressures from lower implement a Medium-Term Revenue Strategy to import prices, domestic currency appreciation strengthen domestic revenues. Unlocking further and monetary policy normalization. In the growth is conditional on the swift implementation subsequent months up to July 2024, inflation of the government’s program, anchored in the EU has remained stable at around 2.1 percent, accession aspiration, and built on reforms tackling mainly driven by wage increases in the private productivity, including improving the business sector, while food and non-alcoholic beverages, environment, and expanding Albania’s integration which constitute close to 35 percent of the into foreign markets. consumption basket, had a deflationary trend. Spotlight: Reaping the Benefits of a Global Workforce 93 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 As of July 2024, the government reported a and household loans registered double digit fiscal surplus, on account of robust revenue growth, at approximately 12.0% and 14.5%. collection and sluggish execution of capital Gross non-performing loans reached the level investment. Budget revenues increased by over of 4.7% in July 2024. The current account 8 percent y-o-y as of July 2024, with growth deficit (CAD) widened in H1, primarily observed in all categories, except grants and driven by the rapid growth of imports and profits, which were mostly affected by the base the decrease in exports of goods. Net FDI effect (as they had picked up in the previous continued to perform strongly, increasing by year). Overall credit increased by 13% y-o-y 8.5%. Foreign currency reserves reached the through July 2024. Both private businesses level of 5.7 billion Euros as of July 2024. Outlook Growth is expected to remain robust at 3.3 Public debt is expected to decline further in percent in 2024, with increased tourism and the medium term. Leading indicators are construction expected to drive exports, and pointing upwards: there is strong tourism consumption and investment growth at rates data and increased construction activity, rising similar as in the pre-pandemic period. The credit growth, positive business and consumer inflation rate is projected to remain below the sentiment indicators, and strong tax revenues. 3 percent target in the medium term, despite Given Albania’s growing reliance on external the increase in wages, which has partially financing, risks related to the exchange rate, been offset by the appreciation of the LEK. interest rate, and refinancing remain elevated. The current account deficit is expected to As a small, open economy, Albania is highly hover at 3.8 percent of GDP in the medium exposed to external shocks, such as a recession term. With higher growth expected, poverty in the EU or further tightening of financing is also projected to decrease. A tighter labor conditions in international capital markets. market could further boost wages. Albania’s Risks to growth emanate from natural disasters primary balance is projected to improve and unfavorable global conditions (including and reach zero percent of GDP from 2024 geopolitical developments). Fiscal risks emanate onwards. Government plans to continue from public-private partnerships and SOEs, in improving tax administration, as envisioned addition to the country’s hydropower-based in the Medium-Term Revenue Strategy. energy sector, due to variation in hydrology. 94 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM ALBANIA - Selected Economic Indicators ALBANIA  2021 2022 2023 2024e 2025f 2026f Real GDP growth (percent) 8.9 4.9 3.4 3.3 3.4 3.4 Composition (percentage points): Consumption 3.7 6.4 -0.3 3.4 2.2 2.3 Investment 4.4 2.1 0.8 2.6 1 0.9 Net exports 0.7 -3.6 3 -2.7 0.2 0.2 Exports 13 2.6 3.6 0.2 2,4 2.5 Imports (-) 12.3 6.2 0.7 2.9 2,2 2.3 Consumer price inflation (percent, period average) 2 6.7 4.8 2.2 2.7 2.9 Public revenues (percent of GDP) 27.5 26.8 27.8 29.2 28.4 28.5 Public expenditures (percent of GDP) 32.1 30.4 29.2 31.6 30.7 30.3 Of which: Wage bill (percent of GDP) 4.5 4 4.3 4.9 4.9 4.8 Social benefits (percent of GDP) 12.3 11.5 11.1 11.4 11.3 11.2 Capital expenditures (percent of GDP) 6.9 5.2 5.1 6.2 5.6 5.5 Fiscal balance (percent of GDP) -4.6 -3.7 -1.3 -2.3 -2.3 -1.8 Primary fiscal balance (percent of GDP) -2.7 -1.8 0.7 0 0 0.5 Public debt (percent of GDP) 71.5 62.1 57.2 55.4 54.4 53.2 Public and publicly guaranteed debt (percent of GDP) 75.4 65.3 59.8 58.3 57.6 56.3 Of which: External (percent of GDP) 36.8 30.2 26.9 25.3 24 22.7 Goods exports (percent of GDP) 8.3 10.8 8.6 8 7.5 7.5 Goods imports (percent of GDP) 33.6 34.6 30 27.1 27.1 27 Net services exports (percent of GDP) 11.8 13.4 16.1 11.3 11.8 11.8 Trade balance (percent of GDP) -13.4 -10.4 -5.2 -7.8 -7.8 -7.7 Net remittance inflows (percent of GDP) 5 4.6 4.4 4.4 4.5 4.5 Current account balance (percent of GDP) -7.7 -5.9 -0.9 -3.9 -3.8 -3.7 Net foreign direct investment inflows (percent of GDP) 6.5 6.6 5.9 5.3 5.3 5.4 External debt (percent of GDP) 62.7 54.3 51.8 50 49 48.5 Real private credit growth (percent, period average) 5.5 2.9 -1.8 - - - Nonperforming loans (percent of gross loans, end of period) 5.7 5 5.2 - - - Unemployment rate (percent, period average) 11.5 10.9 10.7 - - - Youth unemployment rate (percent, period average) 20.9 20.7 22.2 - - - Labor force participation rate (percent, period average) 59.8 62.4 64.1 - - - GDP per capita, PPP (current international $) 16,302 16,782 17,151 17,758 18,408 19,071 Poverty rate (percent of population) 27.1 23.6 21.7 20.1 18.5 17.1 Sources: Country authorities, World Bank estimates and projections. Spotlight: Reaping the Benefits of a Global Workforce 95 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Bosnia and Herzegovina • Real GDP growth rose 2.7 percent in Q1 2024, from 1.7 percent in 2023 due to the modest economic expansion in the EU and a deceleration in investment growth. • Upcoming municipal elections are expected to lead to a widening fiscal deficit to 1.7 percent of GDP in 2024, yet public debt remains around 27.4 percent of GDP. • Living standards are stagnant, in part due to an anemic labor market. Key conditions and challenges long-term growth of 3-4 percent, reforming the economy and the energy system is crucial. BiH has been granted permission by the However, the pace of reform remains slow European Council to begin accession talks in due to lack of consensus on country level March 2024, pending the implementation policies that would bring BiH closer to EU of necessary reforms. To meet the economic membership; furthermore, frequent elections, criteria for EU membership, BiH must tackle widespread corruption, and the fragmented internal market fragmentation by bolstering division of responsibilities between the two nationwide regulatory and supervisory bodies, entities and cantons also contribute to the slow improving the transparency and efficiency pace of reforms. Overcoming these obstacles of the large public sector, and reducing the is vital for BiH to move towards a more footprint of state-owned enterprises. BiH’s prosperous future. economy has shown macroeconomic stability and resilience over the past, including during Recent developments the COVID-19 pandemic. This resilience is attributed to three economic anchors: the In Q1 2024, real GDP growth rose 2.7 currency board (which ties the BiH mark to percent, discontinuing the sharp slowdown in the euro), the statewide collection of indirect 2023. The pick-up in output growth is largely taxes through ITA, and the prospects of EU due to a recovery in private consumption membership. Despite macro stability and fueled by an increase in minimum wages and resilience, real income growth has averaged a tightening labor market. Stronger retail sales only 2 percent per annum from 2009 to 2023, volumes in the first half of 2024 suggest robust leading to stagnant living standards, with real private consumption outcomes during this per capita consumption remaining at just 40 period. Inflation reached 1.8 percent in July percent of the EU27 average. Achieving faster 2024 y/y, compared to 4.0 percent the year convergence with the EU27 remains difficult before, marking a drop in transport prices and due to low investment rates and a growth a slowdown in utility prices. The labor market model that depends on private consumption. showed mixed signals. The employment rate The need for structural reforms is even more rose to 41.9 percent in Q1 2024, up from 41.5 critical given the challenges of a declining percent in 2023, whereas the unemployment population and the likely slowdown in total rate increased to 13.5 percent, a 0.3 percentage factor productivity over the long term. In point increase compared to the previous year. addition, the introduction of the EU Carbon Economic vulnerability to shocks in BiH Border Adjustment Mechanism in 2026 is remains high – according to the 2023 Life in expected to further challenge BiH’s export Transition Survey, 40 percent of the population competitiveness by 2030. To achieve sustained report being unable to save, running into debt, 96 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM or not being able to cover basic household subsidies, social benefits and transfers in FBiH, expenses for longer than 1 month in case of and an 11 percent increase in RS. Nevertheless, loss of their main income source. Higher public debt remains relatively low at around government spending and smaller revenues 27.4percent of GDP. Meanwhile, the current (in GDP terms) contributed to a consolidated account deficit improved to 2.8 percent in fiscal deficit of 0.9 percent of GDP in 2023, 2023. It was almost fully financed by net FDI which followed a surplus of 0.5 percent of inflows, and other investments, mainly foreign GDP the year before. The deficit in 2023 was loans. driven by an estimated 16 percent increase in Outlook An improvement in the EU economic ageing, driven by outmigration, also dampens landscape, coupled with higher private productivity and burdens public service consumption and investment driven by delivery, particularly in health. The economic construction activities, is set to raise real activity rate remains low at around 48 percent GDP growth in BiH to 2.8 percent in compared to the EU average of 75 percent, 2024, and 3.2 percent in 2025. Inflation is with women’s participation at roughly 37 expected to decelerate to half a percent by percent. Gender discrepancies in employment 2026 barring any further external shocks. By remain particularly stark at the lower levels 2026, real output growth is projected to rise of education. Thus, creating conditions to to 3.9 percent fueled by strengthened exports activate the female labor force would benefit and private consumption stemming from economic growth. Furthermore, the sharp rise improved economic conditions in the EU and in minimum wages, in January of 2023 and tightening labor markets in BiH. The current 2024, may impact external competitiveness, account deficit is expected to widen to around which could also be affected by the EU’s Carbon 3.6 percent of GDP due to higher imports of Border Adjustment Mechanism, considering consumer goods. In the last quarter of 2024, that two-thirds of BiH’s electricity production policy makers are focused on the municipal comes from coalfired thermal power plants. In elections leaving little space for economic addition, a lack of digitalization and unified reforms. Several structural challenges hinder databases and registries hampers regulatory stronger output growth. Productivity is compliance and business operations. Finally, affected by the large footprint of state-owned geopolitical risks pose a threat of exacerbating enterprises, which employ a sizable portion domestic political frictions, undermining the of the educated labor force. Population much-needed push for structural reforms. Spotlight: Reaping the Benefits of a Global Workforce 97 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 BOSNIA AND HERZEGOVINA - Selected Economic Indicators BOSNIA AND HERZEGOVINA 2021 2022 2023 2024e 2025f 2026f Real GDP growth (percent) 7.4 4.2 1.7 2.8 3.2 3.9 Composition (percentage points): Consumption - - - 2.7 2.3 3,0 Investment - - - 1.3 1.8 0.5 Net exports - - - -1.1 -0.9 0.3 Exports - - - 0.3 1 1.4 Imports (-) - - - 1.5 1.9 1 Consumer price inflation (percent, period average) 2 14 6.1 2 0.9 0.4 Public revenues (percent of GDP) 41 40.2 41.3 42.2 42.6 43.2 Public expenditures (percent of GDP) 41.3 39.7 42.2 43.9 42.8 43.6 Of which: Wage bill (percent of GDP) 10.3 10.3 10.9 10.9 10.5 10.1 Social benefits (percent of GDP) 14.6 17.4 18.2 19.8 19.9 20.7 Capital expenditures (percent of GDP) 3.5 3.5 3.8 3.8 3.3 3.6 Fiscal balance (percent of GDP) -0.3 0.5 -0.9 -1.7 -0.2 -0.4 Primary fiscal balance (percent of GDP) 0.3 1.1 -0.1 -0.8 0.8 0.6 Public debt (percent of GDP) 33.9 29.3 26.9 27.4 27.2 26.7 Public and publicly guaranteed debt (percent of GDP) 37.6 31.5 28.5 28.2 28.9 28.4 Of which: External (percent of GDP) 29.5 24.9 21.4 21.8 21.5 21.1 Goods exports (percent of GDP) 32.5 35.9 32 31.5 31.4 31.3 Goods imports (percent of GDP) 50.8 58.2 52.8 51.8 51.9 51.3 Net services exports (percent of GDP) 7 8.6 8.1 7.4 7 6.7 Trade balance (percent of GDP) -11.3 -13.8 -12.7 -12.9 -13.5 -13.3 Net remittance inflows (percent of GDP) 7.8 7.9 7.7 7.5 7.4 7.3 Current account balance (percent of GDP) -1.8 -4.3 -2.8 -3.2 -3.8 -3.6 Net foreign direct investment inflows (percent of GDP) 3.3 3 3.2 3.2 3.1 3.1 External debt (percent of GDP) 57.2 48.7 54.4 52.3 50.5 48.5 Real private credit growth (percent, period average) -0.3 -8.1 -0.7 - - - Nonperforming loans (percent of gross loans, end of period) 5.8 5.4 5.2 - - - Unemployment rate (percent, period average) 17.4 15.4 13.2 - - - Youth unemployment rate (percent, period average) 38.3 35.1 30.1 - - - Labor force participation rate (percent, period average) 48 47.6 47.8 - - - GDP per capita, PPP (current international $) 17,377 17,898 18,202 18,712 19,311 20,064 Sources: Country authorities, World Bank estimates and projections. 98 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM Kosovo • Economic activity picked up during the first quarter of 2024, on the back of robust consumption growth as prices stabilized. • Over the medium term, growth is projected to strengthen further, fueled by consumption, rising real incomes, credit expansion, and increased public wages and transfers.   • A strengthened EU accession process, backed by the EU growth plan, has the potential to improve trade integration, attract more FDI and bolster economic growth. Key conditions and challenges infrastructure gaps. The positive trend in the national average for poverty reduction may After a slowdown in 2023, Kosovo’s growth obscure regional disparities. Poverty is more accelerated in the first part of 2024, yet within prevalent among people with lower education the bounds of its structural constraints. The and children, so it is essential to emphasize fiscal performance remained robust, with human capital accumulation. A significant revenue growth continuing to be strong. portion of Kosovo’s workforce comprises the However, the country is confronted with working poor, who face low wages and limited the need to undertake reforms that demand human capital. This situation is exacerbated substantial fiscal resources. Key among by low labor force participation, especially these is the implementation of a new energy among women, influenced by high reservation strategy, improvement of water security, and wages and attractive outside options, including the acceleration of reforms aimed at bolstering migration. human capital and connectivity. Kosovo’s growth model relies mainly on consumption Recent developments and construction investment, financed significantly by the country’s diaspora. Recent GDP growth accelerated in the first quarter growth trends in exports of ICT and other of 2024, with provisional estimates indicating business services are encouraging. Foreign a 5.6 percent increase. Private consumption direct investments in 2024 continue to increase growth (9.7 percent y/y) provided the highest but remain primarily focused on real estate. contribution. On the supply side, net taxes In 2023, labor force participation inched up on products contributed most to the growth. to 40.7 percent. However, the working-age Consumer inflation decelerated, averaging 2.1 population has shrunk, partly due to ongoing percent between January and August 2024. outmigration. Visa liberalization with the EU Core inflation, however, remains elevated (3.6 has reduced costs and spurred an increase in percent by August). Labor market formalization international travel and higher service imports. continued in 2023, reflected in a 4.5 percent The country lags peers in human capital increase in formal employment. The current development. To transition to a growth model account deficit (CAD) for the first half of the that favors more and better-quality jobs, Kosovo year increased by ¼ from the same period of should continue to maintain macroeconomic last year, driven by a higher deficit in the goods stability and accelerate reforms that target the balance. Cumulative remittances’ growth by closing of regulatory, human capital, and vital July slowed down to 0.5 percent, compared Spotlight: Reaping the Benefits of a Global Workforce 99 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 to 11.3 percent during the same period of last decline of 2.2 percentage points in 2024 (from year. By August 2024, the government ran 21.4 percent in 2023) due to slightly higher a fiscal surplus and tax revenues grew by 11 growth. However, growth has been skewed percent, reflecting increased compliance and towards urban centers, leading to increased formalization gains. Meanwhile, expenditures inequality. Another important dimension increased by 14 percent, driven by increases is susceptibility to shocks and its welfare in wage spending. In the first quarter of 2024, consequences. In 2022, price increases reached public and publicly guaranteed debt (PPG) levels not seen in decades, and energy price fell to 15.8 percent of GDP, down from shocks posed concerns for the most vulnerable 17.5 percent in 2023. The financial sector groups. Similarly, geopolitical tensions and remains robust. By July 2024, credit increased subsequent supply-chain disruptions have by 13.6 percent (y/y) and non-performing heightened worries about their effects on those loans remaining stable at 2 percent. Poverty at the lower end of the economic distribution. reduction is projected to continue, with a Outlook GDP growth is projected to accelerate to fiscal deficit is expected to edge up to 1.1 3.8 percent in 2024 and gradually converge percent of GDP in 2024 and remain in line towards 4 percent over the medium-term. with fiscal rules over the medium-term. An Growth is likely to be spurred by consumption, increase in spending pressures associated underpinned by rising incomes, credit, and to the upcoming electoral cycle represents public spending. Public infrastructure and a risk. Continued geopolitical uncertainty, private real estate investments, along with including that associated with the domestic post-2025 renewable energy investments, are political context, also entails risk. A reinforced also expected to contribute to growth. On the EU accession process could enhance growth production side, services and construction will prospects. With growth expected to accelerate, provide the highest contribution. Merchandise poverty is also projected to decrease. A tighter exports will remain subdued in 2024, labor market is anticipated to boost wages. gradually recovering by 2026. International While outmigration has sparked concerns price stabilization is expected to slow domestic about human capital losses, migration can consumer price inflation to 2 percent in 2024. also incentivize the optimal use of domestic However, upward pressure on wages could human capital. The declining population keep core inflation higher. Outmigration and could be offset by increasing female labor force increased travel spending abroad, associated participation, constrained by lack of childcare with visa liberalization, represent a drag on services. Expanding childcare services would growth. The CAD is expected to deteriorate in not only improve labor market opportunities 2024 but improve starting in 2025. Real estate for women but also enhance children’s school FDI is projected to increase, but more greenfield readiness through better early childhood and productive FDI is needed. Driven by education (ECE). higher current and capital expenditures, the 100 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM KOSOVO - Selected Economic Indicators KOSOVO  2021 2022 2023 2024e 2025f 2026f Real GDP growth (percent) 10.7 4.3 3.3 3.8 3.9 4 Composition (percentage points): Consumption 8.3 2.7 3.9 4.6 3.8 4.1 Investment 4.8 -1.1 1 1.7 1.7 1.5 Net exports -2.4 2.7 -1.6 -2.5 -1.5 -1.5 Exports 16.3 6.4 2.4 2.4 1.7 2 Imports (-) 18.7 3.7 4.1 4.9 3.2 3.4 Consumer price inflation (percent, period average) 3.3 11.6 4.9 2 1.9 1.8 Public revenues (percent of GDP) 27.4 27.9 29.4 29.2 29.4 29.6 Public expenditures (percent of GDP) 28.8 28.4 29.7 30.3 31.1 31.4 Of which: Wage bill (percent of GDP) 8.4 7.3 7.9 8.2 8.2 8.3 Social benefits (percent of GDP) 7.8 8.1 7 7.1 7,1 7 Capital expenditures (percent of GDP) 5.3 4.7 5.7 6.1 6.7 7.2 Fiscal balance (percent of GDP) -1.3 -0.5 -0.3 -1.1 -1.7 -1.9 Primary fiscal balance (percent of GDP) -0.9 -0.1 0.2 -0.7 -1.3 -1.4 Public debt (percent of GDP) 21.1 19.7 17.2 17.2 18.1 18.9 Public and publicly guaranteed debt (percent of GDP) 21.6 20 17.5 17.4 18.3 19.1 Of which: External (percent of GDP) 7.2 7.2 7.2 7.8 8.4 8.5 Goods exports (percent of GDP) 9.5 10.5 9 7.7 8.1 8.3 Goods imports (percent of GDP) 54.3 58.7 56.6 53.6 54.1 53.9 Net services exports (percent of GDP) 13 15.4 16.9 16.3 16.4 15.8 Trade balance (percent of GDP) -31.8 -32.8 -30.8 -29.7 -29.6 -29.8 Net remittance inflows (percent of GDP) 14.1 13.4 13.4 12.8 12.8 12.8 Current account balance (percent of GDP) -8.7 -10.3 -7.6 -8.1 -7.6 -7.5 Net foreign direct investment inflows (percent of GDP) 4 6.3 6.8 7.1 7 6.9 External debt (percent of GDP) 37.6 38.6 38.6 39.5 39.8 40.2 Real private credit growth (percent, period average) 7.6 5.2 8.7 - - - Nonperforming loans (percent of gross loans, end of period) 2.3 2 2 - - - Unemployment rate (percent, period average) 20.7 12.6 10.9 - - - Youth unemployment rate (percent, period average) 38 21.4 17.3 - - - Labor force participation rate (percent, period average) 39.3 38.6 40.7 - - - GDP per capita (US$) 5,405 5,445 6,142 6,676 7,119 7,577 Poverty rate (percent of population) 25.5 22.8 21.4 19.2 17.1 15.5 Sources: Country authorities, World Bank estimates and projections. Spotlight: Reaping the Benefits of a Global Workforce 101 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Montenegro • Montenegro’s economy is expected to grow by 3.4 percent in 2024. Growth is projected to moderate but remain solid at 3.5 percent in 2025, boosted by wage increases. • However, fiscal challenges persist as the Fiscal Strategy 2024-27 reduces pension contributions, likely increasing the deficit to 4.1 percent of GDP in 2025. • Public debt is expected to rise to an estimated 64.5 percent of GDP by 2026. • Maintaining fiscal sustainability will require disciplined policies amid high external financing costs and geopolitical uncertainties. Key conditions and challenges pension contributions. After years of political instability following the 2020 elections and Montenegro, characterized by its small open the first power shift in 30 years, Montenegro’s economy, rich biodiversity, and EU ambitions, government, formed in October 2023 and has shown resilience despite vulnerabilities reshuffled in July 2024, has made EU accession to external and domestic demand shocks. As its priority. By March 2024, key judiciary and a euroized economy, it relies heavily on fiscal prosecution appointments were made, and policy for macroeconomic stability. Given in June 2024, a positive Interim Benchmark its reliance on tourism and the challenges Assessment Report marked a crucial step, of environmental degradation and climate enabling the country to begin closing chapters change, the country would benefit from more and move closer to EU membership. sustainable development strategies. After a 15.3 percent contraction in 2020, the economy Recent developments rebounded swiftly in 2021-23, averaging 8.6 percent growth per annum. Growth is estimated The solid growth from 2023 continued into to remain robust in 2024 at 3.4 percent, 2024, although GDP growth moderated driven by private consumption, still supported from 4.4 percent in Q1 to 2.7 percent in by foreign residents, primarily Russian and Q2. While increased private consumption Ukrainian citizens. Montenegro successfully and investment supported growth, their high reduced its public debt from 103.5 percent import dependence led to higher imports, of GDP in 2020 to 59.3 percent in 2023, but weighing on overall growth. By July, real a lumpy debt repayment profile represents a retail trade had grown by 6.4 percent, and the vulnerability. While one-off revenues resulted value of construction works by 3.1 percent. in a fiscal surplus of 0.6 percent of GDP in However, tourist overnight stays fell by 4 2023, a return to fiscal deficits is expected percent, and industrial production by 6.5 in the medium term. Tax revenues remain percent. Strong employment gains across all below 2021 levels following the 2022 reform, sectors continued into 2024. In Q2, LFS data which removed healthcare contributions and (15-89) showed employment and activity rates introduced the PIT allowance (Europe Now 1). of 56.7 percent and 64 percent, respectively, Under the government’s Fiscal Strategy 2024- while the unemployment rate dropped to 11.4 27 (Europe Now 2), revenues are projected to percent. By July, annual inflation averaged decline further with the proposed reduction in 4.6 percent, and real wages increased by 1.2 percent y/y. Poverty (income below $6.85/day 102 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM in 2017 PPP) is projected to have declined to of the CAD, with the remainder financed 8.8 percent in 2023. The financial sector is through new debt. External debt stays high well capitalized and liquid, and credit growth at 130 percent. In the first seven months of remains strong. In June, the average capital 2024, the central government achieved a fiscal adequacy ratio was at 19.5 percent, while surplus of 0.4 percent of GDP. Revenues non-performing loans declined to 5 percent rose by 8.6 percent, despite one-off revenues from 6.1 percent of total loans a year ago. in 2023, supported mainly by stronger VAT By June 2024, banking sector lending and and CIT collection. Expenditures grew by deposits increased by 12.5 and 2.1 percent y/y 17.9 percent, mainly due to increased social respectively. In H1, the current account deficit transfers following the minimum pension (CAD) widened due to lower service exports increase to €450 in January 2024. In June, and a decline in net income accounts, driven public debt stood at 60.8 percent of GDP, and by higher dividend and interest payments. in September, S&P upgraded Montenegro’s Net FDI fell by 5 percent, covering a third credit rating from ‘B’ to ‘B+’. Outlook The growth outlook is positive albeit further requires targeted government policies challenged by an unfavorable global alongside sustained economic growth. The environment. Coming from a very high base, fiscal deficit is expected to increase in 2025 growth is expected to moderate to 3.4 percent to an estimated 4.1 percent of GDP before in 2024, still led by private consumption, but gradually declining to 3.7 percent in 2026. The also investments. Considering the anticipated announced reduction in pension contributions increase in the minimum and net wages is expected to create a revenue shortfall despite from October 2024 as reflected in the Fiscal the government’s planned compensatory Strategy, personal consumption is expected to measures. Implementing additional fiscal boost growth in 2025 to 3.5 percent, despite a consolidation measures would improve fiscal closure of the thermal power plant in 2025 for performance and help ensure sustainability. reconstruction that will require greater energy Public debt is expected to rise to an estimated imports. Medium-term growth is expected to 64.5 percent of GDP by 2026. Maintaining be sustained and stimulated by Montenegro’s debt sustainability will require strong fiscal progress towards EU membership. The CAD discipline, especially amid challenging global is projected to widen to 12.6 percent of GDP financial conditions and significant financing in 2024 and further to 13.7 percent in 2025 needs over 2025-27. The outlook is clouded due to higher energy imports, with much of by potential downside risks. Heightened it financed by net FDI. Inflation is expected geopolitical uncertainties may weaken growth to soften only slightly to 3.7 percent in 2025 prospects for Montenegro’s trading partners, and further to 2.7 percent in 2026. Poverty is while the high cost of external financing poses projected to decline by 1.8 percentage points a risk given the country’s substantial financing from 2023 to 7 percent in 2026. Most of the needs. Domestic political developments also poor are chronically unemployed, students, pose a risk. or out of the labor force, often living in the northern region. Thus, reducing poverty Spotlight: Reaping the Benefits of a Global Workforce 103 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 MONTENEGRO - Selected Economic Indicators MONTENEGRO 2021 2022 2023 2024e 2025f 2026f Real GDP growth (percent) 13 6.4 6.3 3.4 3.5 3.2 Composition (percentage points): Consumption 3.6 8.1 5.9 3.9 4.5 3.2 Investment -2.4 3.3 0.7 1.7 1.2 0.8 Net exports 11.8 -5 -0.3 -2.2 -2.2 -0.8 Exports 21 9.4 4.3 0.2 1.8 1.9 Imports (-) 9.1 14.3 4.5 2.4 4.1 2.7 Consumer price inflation (percent, period average) 2.4 13 8.6 4.2 3.7 2.7 Public revenues (percent of GDP) 44 38.6 42.2 41.5 39.7 39.7 Public expenditures (percent of GDP) 46.1 43.4 41.6 44.4 43.8 43.3 Of which: Wage bill (percent of GDP) 12.2 10.5 10.5 10.5 10.3 10 Social benefits (percent of GDP) 11.5 11.3 11.9 13.6 13.3 13.1 Capital expenditures (percent of GDP) 5.7 6 5 5.5 5.4 5.4 Fiscal balance (percent of GDP) -2.1 -4.9 0.6 -2.8 -4.1 -3.7 Primary fiscal balance (percent of GDP) 0.2 -3.3 2.4 -0.8 -1.8 -1.3 Public debt (percent of GDP) 84 69.2 59.3 62.2 61.6 64.5 Public and publicly guaranteed debt (percent of GDP) 86.8 70.9 60.8 63.6 62.9 65.7 Of which: External (percent of GDP) 77.6 61.8 52.3 58.8 57.9 60.9 Goods exports (percent of GDP) 10.6 12.9 10.3 9.2 9 9.2 Goods imports (percent of GDP) 49.3 58 53.2 52.3 52.9 52.4 Net services exports (percent of GDP) 19.3 22.2 24.2 23.7 23.9 24 Trade balance (percent of GDP) -19.4 -22.9 -18.7 -19.4 -20 -19.2 Net remittance inflows (percent of GDP) 6.1 6.5 4.8 4.6 4.5 4.5 Current account balance (percent of GDP) -9.2 -12.9 -11.4 -12.6 -13.7 -13.2 Net foreign direct investment inflows (percent of GDP) 11.7 13.2 6.2 7 7 7 External debt (percent of GDP) 191.7 158.4 129.9 130.2 128.8 134.1 Real private credit growth (percent, period average) -0.2 -4.9 -2.3 - - - Nonperforming loans (percent of gross loans, end of period) 6.8 6.3 6.4 - - - Unemployment rate (percent, period average) 16.6 14.7 13.1 - - - Youth unemployment rate (percent, period average) 37.1 29.4 23.3 - - - Labor force participation rate (percent, period average) 50.9 58.9 63.9 - - - GDP per capita, PPP (current international $) 23,318 27,027 30,880 33,148 34,814 36,638 Poverty rate (percent of population) 12.2 10.1 8.8 8.1 7.5 7 Sources: Country authorities, World Bank estimates and projections. 104 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM North Macedonia • Real growth remained constrained in H1 2024 amidst lingering inflationary pressures, weak external demand, and delayed highway construction. • Fiscal consolidation targets are likely to be missed for 2024 following election promises. The fiscal deficit and public debt remain elevated over the medium term with higher mandatory spending and build-up of fiscal risks related to arrears, pensions, and spending pressures ahead of local elections. • The growth outlook is positive, but downside risks prevail. Key conditions and challenges of peers. Ensuring sustainability, rising productivity, and undertaking necessary labor North Macedonia is struggling to recover and regulatory structural reforms are essential after crises. Real GDP growth has remained for EU accession to progress and to enable muted in 2024, after mere 1 percent in sustainable growth. 2023, reflecting delays in the take-off of highway construction works, weaker external Recent developments demand, and lingering price pressures. Poverty reduction, having stalled in 2023, is estimated Output growth averaged 1.8 percent in H1 to have resumed in 2024 due to rising wages 2024 with strong domestic demand while and employment growth vis-à-vis 2023. Fiscal exports and imports dropped. Services led challenges remain persistent. While some growth, while construction picked up and reforms have been made to boost domestic agriculture had a negative contribution. revenues, spending efficiency remains low, and Relative to end-2023, labor market indicators fiscal discipline weak. The fiscal deficit remains in Q2 2024 improved slightly, with the at around 5 percent post-pandemic, pushing employment rate rising by a notch to 45.6 the debt-to-GDP ratio close to 62 percent of percent, while the participation rate remained GDP. Both the fiscal deficit and public debt almost unchanged at 52.1 percent. The remain above the newly introduced fiscal rules, unemployment rate dropped slightly to 12.5 further challenged by pre-election spending percent, and the youth unemployment rate (15- commitments related to pensions, public 24) remained high at 26.9 percent. Nominal sector wages, and transfers to municipalities. net wage growth, driven by public sector and Monetary tightening has helped contain the minimum wage increases, spiraled up to 14.8 surge in prices but persistent inflationary percent in June 2024, outpacing inflation by pressures risk prolonging the tightening cycle close to 12 pp. While headline inflation eased and further dampening economic activity. from double-digit growth in 2022 to 3 percent Rising wages and pensions risk keeping in July 2024, core inflation remains high—at inflation higher for longer and cause a slower above 5 percent, led by wage pressures and return to the long-term average. Crisis induced services. At the same time, the Central Bank scars to the economy have significantly slowed initiated the first policy rate cut of 25 basis potential growth and income convergence points to 6.05 percent in September 2023. with the EU. The country’s rebound after The fiscal deficit (with the state roads finances the pandemic has not kept pace with that included) is projected to reach 5.1 percent of Spotlight: Reaping the Benefits of a Global Workforce 105 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 GDP in 2024 after a July budget revision that 18.9 percent in Q1 2024, while the liquidity increased spending on wages, pensions and rate (without government securities) settled transfers, and lowered capital spending. Public around 20 percent. At the same time, the debt went up to 61.5 percent of GDP in Q2 NPL ratio increased, but solely as a result of 2024, mostly on account of higher issuance of methodological changes. The CAB returned domestic securities. Expenditure arrears have to negative territory at 1.2 percent of GDP in surged to 4.7 percent of GDP in Q2 2024 H1 2024 owing to a worsening of the goods on account of poor fiscal discipline of local trade balance, while services exports held up utility companies, public health institutions, and remittances eased. External debt slightly and state-owned enterprises. Banking sector declined to 81.8 percent of GDP in Q1 2024, stability has been maintained in line with but roughly half of the total is private and an increase in the capital adequacy ratio to mostly intercompany lending. Outlook The medium-term outlook remains positive, priority for the new administration that won but risks are tilted strongly to the downside. general elections in May 2024. At the same Growth is expected to step up in the medium time, low productivity, inefficient capital term to an average of 2.7 percent during 2025- deployment, and weak external demand, 2026. This projection assumes a rebound of compounded by limited fiscal space and rising public investments and a gradual recovery of fiscal risks amidst high interest rates, continue consumption and exports. Headline inflation to impede growth prospects and further slow is projected to remain above or close to 3 the pace of income convergence with EU percent in 2024-25, but to slow thereafter to peers. Additional delays of decarbonization a long-term average of 2 percent. Poverty rates targets, along with carbon pricing, risk a loss are projected to maintain a slow declining in domestic public revenues and international pathway, helped by real wage and employment competitiveness given the start of the EU growth, falling by a further 1.2 percentage Carbon Border Adjustment Mechanism. In points over the forecast period. The baseline this context, following up on the Growth scenario is built on the assumption that the Plan pledges is critical to carve out a growth- focus on the EU accession agenda remains a conducive economic environment. 106 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM NORTH MACEDONIA - Selected Economic Indicators NORTH MACEDONIA 2021 2022 2023 2024e 2025f 2026f Real GDP growth (percent) 4.5 2.2 1 1.8 2.5 3 Composition (percentage points): Consumption 6.7 2.2 1.8 2 1.4 2.1 Investment 1.4 3.7 -6.7 0.5 1.1 1.2 Net exports -3.6 -3.8 5.9 -0.8 0 -0.2 Exports 9.1 7.9 -0.1 2.2 3.9 4.4 Imports (-) 12.7 11.7 -6 3 3.9 4.6 Consumer price inflation (percent, period average) 3.2 14.2 9.4 3.5 2.8 2 Public revenues (percent of GDP) 32.1 32.1 34.9 37.3 37.1 37.1 Public expenditures (percent of GDP) 37.4 36.6 39.6 42.1 41.2 40.8 Of which: Wage bill (percent of GDP) 6.8 6.5 7.2 8.1 8.1 7.9 Social benefits (percent of GDP) 16.7 16.4 17.7 19.1 18.3 17.7 Capital expenditures (percent of GDP) 4.2 4.2 5.7 6 5,8 5,9 Fiscal balance (percent of GDP) -5.3 -4.5 -4.7 -4.9 -4 -3.7 Overall fiscal balance with the Public Enterprise for State -5.7 -4.8 -4.9 -5.1 -4.3 -3.9 Roads included (percent of GDP) Primary fiscal balance (percent of GDP) -4.1 -3.4 -3.1 -2.9 -2 -1.3 Public debt (percent of GDP) 51.4 50.4 54.1 56.3 57.8 58.8 Public and publicly guaranteed debt (percent of GDP) 60.3 59 62 63.5 63.1 62.8 Of which: External (percent of GDP) 39.4 38.7 39.1 40 39.8 39.6 Goods exports (percent of GDP) 51 56.2 53.5 53.1 53.7 53.8 Goods imports (percent of GDP) 70.8 82.9 72.3 73.2 74.5 75.3 Net services exports (percent of GDP) 4.2 5.8 5.4 6.5 7.9 9.2 Trade balance (percent of GDP) -15.6 -20.9 -13.5 -13.6 -13 -12.3 Net remittance inflows (percent of GDP) 2.9 2.7 2.5 2.4 2.3 2.3 Current account balance (percent of GDP) -2.8 -6.1 0.7 -1.8 -2 -2 Net foreign direct investment inflows (percent of GDP) 3.3 5 3.8 3.7 3.5 3.4 External debt (percent of GDP) 80.9 82.8 82 84.7 84.8 84 -2.9 -5.3 7.4 -0.1 0.7 0.7 Real private credit growth (percent, period average) 2.8 -4 -2.9 - - - Nonperforming loans (percent of gross loans, end of period) 3.1 2.8 2.8 - - - Unemployment rate (percent, period average) 15.4 14.4 13.1 - - - Youth unemployment rate (percent, period average) 36.1 32.5 29.3 - - - Labor force participation rate (percent, period average) 55.8 55.2 52.3 - - - GDP per capita, PPP (current international $) 18,934 20,329 20,532 20,902 21,424 22,067 Poverty rate (percent of population) 18.7 17.8 17.6 16.9 16.1 15.8 Sources: Country authorities, World Bank estimates and projections. Spotlight: Reaping the Benefits of a Global Workforce 107 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 Serbia • The growth of the Serbian economy accelerated in the first half of 2024 leading to an increase in projected GDP growth for the year as whole to 3.8 percent. • The incidence of poverty declined to an estimated 6.9 percent. However, there is a possibility of revising down the projected growth considering the severe drought that hit Serbia in 2024. • Poverty reduction is projected to continue at a much slower pace, as the remaining poor are often characterized by chronic unemployment and thus not benefiting from positive market trends. Key conditions and challenges Recent developments Growth in 2024 is projected at 3.8 percent, Strong GDP growth in Q1 and Q2 2024 (4.6 y/y, higher than the previously projected figure and 4 percent, y/y) was driven by a recovery of 3.5 percent thanks to a better-than-expected of private sector consumption and investment. performance of the construction and services On the other hand, net exports made a sectors in the first half of the year. However, a negative contribution to growth in the first severe drought that hit Serbia this summer had half of the year due to lower-than-expected a significant negative impact on agriculture, exports growth, as external demand weakened, which may still cause a downwards revision of and imports remained at a high level (in 2024 GDP projections. On the expenditure part explained by increased investment). side, consumption and investment were the Manufacturing remained resilient to external main drivers of growth in the first half of 2024 developments. Its output was 3.6 percent while net exports had a negative contribution. higher over the first seven months (y/y) thanks Consumption started to recover because of to a good performance of the food, tobacco, the continued increase in incomes as well as a metals, electronics and automotive sectors. steady decline in inflation. In order to reduce Labor market indicators improved slightly the high degree of volatility associated with in the first half of 2024. The unemployment the agriculture (and related food industry) rate reached 8.2 percent in Q2 2024 (a record output, Serbia needs to introduce policy and low since Q2 2020) and the employment rate investment measures to mitigate the negative continued to increase (to reach a record high impact of increasing climate shocks and to level of 51.4 percent) even though informal promote private sector participation in these employment declined marginally. Wages measures. Over the medium term, under the increased by 14.7 percent in nominal terms (9.2 baseline scenario, the Serbian economy is percent, in real terms) in H1 2024 compared expected to grow at around 4 percent. With to the same period of 2023. Poverty (based on limited space for future stimulus packages, the upper-middle income line of $6.85/day structural reforms are needed to accelerate in 2017 PPP) is estimated to have declined private sector led growth. from 7.5 percent in 2021 to 6.9 percent in 2022. In 2023, poverty levels are likely to have stayed the same, as private consumption growth was modest, affected by the high 108 Spotlight: Reaping the Benefits of a Global Workforce RETAINING THE GROWTH MOMENTUM inflation and the phasing out of government a continued decline over 15 months (February support programs, which had fueled the strong 2023-May 2024) public debt increased post-COVID-19 recovery of 2021. Inflation significantly in June 2024 (by 2.1pp) to reach continued to gradually decline in the first half 52.6 percent of GDP. The current account of 2024, mainly due to a significant decline in deficit is expected to increase to 4.1 percent of food related inflation. However, the headline GDP in 2024. Over the first half of the year the inflation index edged up again in July, due to CAD already more than doubled compared to an increase in food prices, most likely because the same period of 2023. The trade balance of the drought. The NBS kept unchanged the keeps widening as well as the primary income key policy rate at 6.5 percent from July 2023 deficit. At the same time net transfers declined through June 2024 when it was lowered for marginally, although still reporting a major the first time. Currently the key policy rate is surplus. Net FDI has continued to perform 6 percent. Budgetary revenues overperformed strongly, remaining broadly unchanged in significantly in H1 2024 (up 14.1 percent euro terms (at EUR 2 billion in H1). Foreign in nominal terms, y/y), primarily thanks currency reserves increased to a record high to a higher-than-planned collection of level of EUR 27.5 billion by June. Overall contributions for social insurance, VAT, and credit decreased by 1.2 percent (y/y) through excises. Over the same period, expenditures June 2024. However, loans to private businesses increased by 15.2 percent in nominal terms. and households were up by 7.3 percent and As a result, the consolidated fiscal surplus was 4.8 percent respectively. Gross nonperforming lower than in the same period of 2023, while loans declined to 2.9 percent in June 2024. still reaching 0.4 percent of annual GDP. After Outlook The Serbian economy is expected to grow at fiscal deficit is now projected at a higher level around 4 percent over the medium-term, than before since the government decided driven primarily by consumption and to some to de facto suspend fiscal rules until 2029, extent by investment. There are both up and in the context of largescale infrastructure downside risks. Downside risks relate to the public spending plans. Continued economic impact of climate change on agriculture and growth will keep bringing more Serbians out infrastructure. On a positive side, there could of poverty. However, the remaining poor are be a more significant impact of exports on increasingly concentrated among pensioners, growth, including but not limited to the recent the long-term unemployed or those completely private sector investment in the automotive out of the labor force. Thus, targeted social sector. Inflation is expected to decline gradually assistance or other direct channels will become and to stay within the NBS target band. The essential to continue poverty reduction. Spotlight: Reaping the Benefits of a Global Workforce 109 WESTERN BALKANS REGULAR ECONOMIC REPORT NO.26 FALL 2024 SERBIA - Selected Economic Indicators SERBIA 2021 2022 2023 2024e 2025f 2026f Real GDP growth (percent) 7.7 2.5 2.5 3.8 4.2 4 Composition (percentage points): Consumption 6.1 2.8 0.6 3.4 3.4 3.4 Investment 2.5 1.2 -0.6 2.9 1.8 1.5 Net exports -0.9 -1.5 2.5 -2.5 -0.9 Exports 10.9 9.9 1.6 4.2 4.7 4 Imports (-) 11.8 11.4 -0.9 6.7 5.7 5 Consumer price inflation (percent, period average) 4 11.9 12.1 4.5 3.1 3 Public revenues (percent of GDP) 43.2 43.4 42.6 43.3 43.4 43.2 Public expenditures (percent of GDP) 47.4 46.4 44.8 45.5 45.9 45.5 Of which: Wage bill (percent of GDP) 10 9.6 9.5 10.1 10,1 10,1 Social benefits (percent of GDP) 13.6 13.1 13.5 13.8 14,2 14,0 Capital expenditures (percent of GDP) 7.4 7.2 7 7.9 8,0 8,0 Fiscal balance (percent of GDP) -4.1 -3 -2.2 -2.2 -2.5 -2.3 Primary fiscal balance (percent of GDP) -2.4 -1.5 -0.4 -0.2 -0.5 -0.5 Public debt (percent of GDP) 54.5 53 49.7 49.6 48 46 Public and publicly guaranteed debt (percent of GDP) 57.1 55.6 52.6 52 50.4 48.4 Of which: External (percent of GDP) 34.7 35.7 36.5 37 36.5 36 Goods exports (percent of GDP) 39.4 44.6 40.2 39.8 40.6 40.9 Goods imports (percent of GDP) 50.7 60.1 49.7 50.1 51 51.5 Net services exports (percent of GDP) 2.6 3.8 4.3 4.2 4 4.2 Trade balance (percent of GDP) -8.7 -11.7 -5.2 -6.1 -6.4 -6.5 Net remittance inflows (percent of GDP) 4.7 6.2 5.4 5 4.8 4.7 Current account balance (percent of GDP) -4.3 -6.9 -2.6 -4.1 -4.7 -5 Net foreign direct investment inflows (percent of GDP) 6.9 7.2 5.5 5.5 5.5 5.5 External debt (percent of GDP) 68.4 69.3 67.2 64.5 62.9 60.4 Real private credit growth (percent, period average) 3.7 -2.7 -9.2 - - - Nonperforming loans (percent of gross loans, end of period) 3.6 3 4 - - - Unemployment rate (percent, period average) 11.1 9.5 9.4 - - - Youth unemployment rate (percent, period average) 26 24.3 25 - - - Labor force participation rate (percent, period average) 53.8 54.7 55.4 - - - GDP per capita, PPP (current international $) 21,902 24,655 26,305 27,985 29,866 31,776 Poverty rate (percent of population) 7.5 6.9 6.7 6.2 5.8 5.4 Source: Country authorities, World Bank estimates and projections. 110 Spotlight: Reaping the Benefits of a Global Workforce Retaining the Growth Momentum Western Balkans Regular Economic Report No. 26 - Fall 2024