Central Europe Review: politics,
society and culture in Central and Eastern Europe
Vol 1, No 23
29 November 1999

Sam Vaknin A   B A L K A N   E N C O U N T E R:
In the Wake of Broken Promises
Will misconceptions kill the Macedonian economy?

Sam Vaknin

I am often accused of writing excoriating, biased diatribes of the Balkans. I often do. But the ignorance of the West regarding this area is no less deserving of a similar treatment.

Let us take Macedonia. Not long ago a terra incognita on the fringes of an ever-solidifying Europe.

Macedonia is the subject of many misperceptions and wrong data. Here are a few examples:

The Macedonian market is very small.

Most people assume the Macedonian market to cover no more than two million consumers. But the truth is that through its well developed and growing system of symmetrical and asymmetrical array of free-trade agreements Macedonia provides access to well over 60 million consumers in the region – from Turkey to Slovenia.

Macedonia's largest trading partners are the former republics of Yugoslavia and especially the Federal Republic of Yugoslavia

Macedonia's biggest market by far – almost 60 percent of its trading volume, both exports and imports – is the European Union. Its position is comparable to the Czech Republic in that more than 75 percent of its international trade is conducted with either the European Union or with the USA.

Macedonia's gross domestic product (GDP) per capita is approximately USD 700.

Such a figure can be found in the CIA Fact-Book 1999. But this is a wrong datum.

Macedonia's GDP per capita in 1998 was USD 1865 per capita. Adjusted to purchasing power (PPP) and taking into consideration the informal sector of the economy Macedonia’s GDP per capita is probably about USD 5000 per annum.

By comparison, the Czech Republic's non-PPP adjusted per capita GDP is also USD 5000.

Macedonia's level of corruption is exceedingly high.

According to Transparency International, Macedonia's rate of corruption is medium (it is in the 66th place out of 99 countries in the 1999 report). It has one of the lowest rates of violent crime and property crimes in the world – although, unfortunately, property crimes and drug-related crimes are on the rise as modernization proceeds apace.

The level of wages in Macedonia is comparable to other developing countries.

This is untrue. Macedonia's workforce – one of the most well-educated in the countries in transition – is much cheaper in relative terms than the workforce in other countries in transition. The average salary in Macedonia is comparable to most other countries in transition and is around 300 DM a month.

But the productivity of the Macedonian worker, as measured by GDP per worker, is much higher. Macedonia produces (without the informal sector of the economy) around USD 3.5 billion a year with around 350,000 active workers. This is about USD 10,000 per worker. The salary paid to a Macedonian worker constitutes, therefore, 20 percent of his product.

Macedonia is investor averse.

Investors ignored Macedonia mainly, if not only, because of geopolitical external shocks. Despite this, Macedonia succeeded in attracting almost USD 192 million in the year 1997-8. Another USD 200 million will probably be invested in 1999, the year of Kosovo and the refugee crises.

Macedonia is the first nation in transition to have legislated for free economic zones and it has an impressive array of tax and investment incentives in place. By implementing a one-stop shop concept, it is doing its utmost to isolate the prospective investor from red tape and potential official corruption. It is gradually but steadily injecting added transparency into the investment and procurement processes. And it is transforming itself into a free-trade hub and the axis of a regional free-trade zone in conjunction with its neighbours, with whom it is now on historically unprecedented friendly terms.

Investors believe that property rights in Macedonia are poorly developed and protected.

Unfortunately, this is still true, despite a discernible trend of improvement. Even though Macedonia has a fine legislation infrastructure, its courts, bureaucrats, banking system, collateral system and registrars systems are all poorly developed and dysfunctional to varying degrees.

This is a top priority of the current administration. Legislation is being adapted, law enforcement agents – especially judges – are being educated and mortgage registration, collateral registration, company registrars are all being revamped. The aim is to provide the investors with maximum protection of their rights and property.

Macedonia is making progress. Today the main problem is not securing property rights or due process. The main problem is the delay, the time lag and the backlog in doing so. This is an improvement over the past – but it is still a sorry state. The administration is aware of it and undertakes to change the situation. In the meantime, the office of every minister and every civil servant is open to investors, who are provided with unparalleled access to the highest level of government.

Remember: Macedonia never had problems of currency convertibility, repatriation of profits or investments or default. Its debt is low by international standards (60 percent of GDP, most of it long-term). It has three months of imports in foreign currency reserves. Its debts are trading at 75 percent of their face value – better than most developing countries, a sign of international confidence in its obligations.

Macedonia's infrastructure is underdeveloped.

Don’t forget that Macedonia was a part of one of the most sophisticated markets in the world – the Former Yugoslav Federation. Its infrastructure is insufficient and often badly maintained – but not uniformly so.

Some types of infrastructure are highly developed, even by European standards. For instance, there are more than 40,000 mobile phone subscribers in an adult workforce of less than 750,000 people. Macedonia has one of the most developed wireless paging systems in Europe – it far surpasses the paging systems of Central Europe. It is rich in electronic media. The Internet is widespread. It has a few German-quality autobahns connecting Macedonia to its neighbours.

Macedonia is isolated and in a war zone.

Yes, Macedonia is situated in a turbulent area.

But it is also an area bigger and richer than Central Europe.

And Macedonia has never been involved in any war activities. It has always been an island of stability and smooth democratic transition.

It hasn't been isolated for years now. Its good neighbour Greece is one of its greatest trading partners and investors. Its other good neighbour Bulgaria has just signed a series of economic collaboration agreements with Macedonia?, including a free-trade agreement.

With the advent of the reconstruction of the Balkans, Macedonia is a uniquely positioned multi-ethnic society, with Albanians and Macedonians in its government. Trusted by all its neighbours, it is bound to become a pivotal player in the stability and growth of this part of the world.

Macedonia's orientation is not clear.

Macedonia has adopted enthusiastically and consensually a free-market approach and a democratic orientation (as have most other countries in transition).

It is a pro-Western, pro-European country aspiring to become a member of the Euro-Atlantic structures.

It is a shell-shocked country.

At first, Macedonia embarked enthusiastically on the road to the construction of a law-abiding state and the establishment of a liberal economic system and the institutional infrastructure to go with it. This led to the development of an open-market economy and pluralism in the ownership relations, all in the face of massive problems.

The latter were only partly the outcome of an inherited lower level of development and unfavorable economic structure. Mostly they were the results of the loss of what were once traditional markets by sanctions imposed on the Federal Republic of Yugoslavia (FRY) and transportation blockades imposed by the Republic of Greece – not to mention frequent armed unrest amongst all its neighbours (Bulgaria, Albania, Yugoslavia, Bosnia Herzegovina and Croatia). In other words, the problems were the results of only external shocks rather than of internal impediments.

The dependence of Macedonia on its markets in the FRY exceeded 70 percent in 1991. The damage caused by the Greek blockade and the embargo imposed on Yugoslavia cost Macedonia more than USD 3.5 billion. As a result of the Gulf war, around USD 300 million worth of construction works in Iraq have remained unpaid.

Moreover, there was little cooperation between the domestic authorities and the economy. Most legislative and judicial developments did not correspond to the situation in practice and still are subject to frequent changes (for example, tax laws, monetary policy and banking, laws in the fields of foreign trade, finance and accounting, the regulation of the debtor and creditor relations, and bankruptcy procedures).

In parallel, the market-related authorities were slow in forming, were weak and inconsistent and the country was plagued by rampant nepotism, protectionism and corruption, which had an adverse impact on the qualities of the human capital.

Until 1998, Macedonia was largely by-passed by foreign investors, and as late as 1998, a meagre USD 192 million was invested in the country. During this time, the informal economy constituted between 40 to 50 percent of the official one, eradicating any private initiative whatsoever.

In spite all of this, as of 1996, production started to pick up. The growth rate in 1998 was 4.5 percent. From 1994 till the present year, inflation ranged between 7.5 and 4.5 percent annually.

But the recovery was not to be. The Kosovo conflict nipped it in the bud.

After the war and the reconciling of accounts it turned out that, apart from the territories directly involved in the war, Macedonia was the most affected of all the countries adjacent to Yugoslavia.

Macedonia and Albania sheltered refugees whose number amounted to 15 percent of their total population. Macedonia has lost a trade partner which constituted 18 percent of its trading turnover.

Macedonia claim about USD one billion in direct damages. Yet, to arrive at a safer and more reasonable estimate, one needs to distinguish between irreversible and reversible damages. The former have a corrosive, pernicious effect - the latter, though harmful and painful, can be remedied through added aid and investment and the adoption of the right frame of mind.

The trade sector in Macedonia suffered approximately USD 50 million in damages over the past three months. This loss can be attributed to the blocking of 18 percent of the trade turnover (with FRY) - 40 percent of which was net value added to the economy.

Some of this trade can and will be revived. Some companies - those that are big and resourceful - will survive. Many small and medium sized trading and manufacturing firms are doomed. The latter is an irreversible effect. It has no beneficial effects on the economy because it is the result of the unnatural selection of war. Perhaps the introduction of microcredits and loans directed at small to medium enterprises can help revive this sector, but it is doubtful whether the whole damage can be undone.

Macedonia's transportation costs are higher than those of any other country (it is a landlocked country, entirely dependent on land trade paths). USD 50 million were added to the transport costs of Macedonian exporters having to ship and truck their goods in roundabout ways throughout half Europe to circumvent the war zone. This predicament is not entirely behind Macedonia but it is slowly getting better.

Direct damage of USD 150 million was inflicted upon the textile, tourism, electro and heavy machinery and chemical industry, not to mention other sectors of the economy. Some of it is irreversible. The tourism season is behind Macedonia, for instance. The hope is to resuscitate the orders and business cycle next year. A long shot perhaps, but a must if the economy as a whole is to survive.

The result of all the above was an increase in unemployment, both hidden and official. The official estimate is that 50,000 people lost their jobs. This cost the government more than USD one million in direct unemployment benefits. More importantly, it cost the nation around USD 25 million in lost GDP. It is part of the decrease in the projected growth of the GDP that is directly attributable to the war. While a cyclical reaction, due to the closure of firms, some unemployment is likely to remain with Macedonia structurally.

The list of other damages is long. The infrastructure (such as roads, electrical grid, sewage system, water system, cellular and fixed telephony) endured USD 25 million in damages. Roads don't take kindly to tanks and airports don't react favourably to multiple landings of heavy cargo planes. Macedonia has expended more than USD 100 million in direct outlays on the 250,000 refugees who arrived within the first few days of the conflict (numbering some 12 percent of the population).

The net foreign borrowings of Macedonia increased and its debt-servicing bill has already gone up by USD four million quarterly. Unless donor conferences and foreign governments meet their pledges, Macedonia is likely to find itself in dire straits.

The signs do not augur well: out of USD 60 million of grant aid pledged, Macedonia has received less than a third and only about ten percent of the total pledges of aid, grants, credits and donations hitherto.

Initially, the government's cash inflow collapsed both externally (unfulfilled pledges and the apparent intransigence of the International Monetary Fund) and internally (lost tax and customs revenues amounting to around USD 25 million).

But some damages are more "catastrophic" than other. Who will help change the mind of those investors who chose not to invest in Macedonia due to the war? Foreign direct investment decreased by USD 42 million this quarter from a miserly basis of USD 50 million. Will the devaluation of the Macedonian denar against the US dollar which increased foreign debt servicing bill by USD 70 million be reversed? And the clear though yet unquantifiable increase in inflation - how can one quantify the long term, all-pervasive and venomous effects of this disease?

Macedonia's credit rating - which improved by an average of 50 points in the last three years depending on the rating agency - has slumped back.

The damage in added costs of foreign borrowings is incalculable.

Inflation and devaluation signify a domestic loss of trust in the economy. The decrease in credit rating indicates a foreign loss of trust in it. This loss of trust both internally and externally is the most worrisome. It has to be fought tooth and nail so that it does not take hold. Coupled with (hopefully a cyclical and reversible) increase in crime, politically motivated terrorism, social unrest (an increasing number of strikes) and a massive diversion of management resources on all levels - it could prove insurmountable if not determinedly mastered.

Dr Sam Vaknin, 29 November 1999

The author is General Manager of Capital Markets Institute Ltd, a consultancy firm with operations in Macedonia and Russia. He is an Economic Advisor to the Government of Macedonia.

DISCLAIMER: The views presented in this article represent only the personal opinions and judgements of the author.

Dr Vaknin's website is here.



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