Multi-dimensional Review of the Western Balkans

Assessing Opportunities and Constraints

Report

OECD Development Pathways

10 June 2021

2. Multi-dimensional analysis of development in the Western Balkans

Abstract

Achieving rapid, inclusive and sustainable development requires progress across a range of development domains. This chapter identifies the key capabilities and most pressing constraints in the Western Balkans by linking economic, social, environmental and institutional objectives. The assessment is organised around five thematic sections based on the five pillars of the United Nations 2030 Agenda for Sustainable Development: People, Prosperity, Partnerships and financing, Peace and institutions, and Planet.

People

Despite the financial crunch COVID-19 will present, Western Balkan economies cannot afford to miss opportunities for investment in their human capital. The region needs to improve access to jobs for all and to develop future-proof education systems. The health and social protection infrastructure needs to be better resourced and modernised, more efficiently organised and made more inclusive of those most in need.

Social cohesion is limited, and many people are left behind

Poverty remains an issue in the region, and regional disparities are significant. Poverty rates of Western Balkan economies vary but remain high compared to benchmark countries in Central and Eastern Europe (Figure 2.1). Subregional inequalities in economic development and well-being exist in all countries. In Albania, Tirana accounts for about 52% of all jobs, while social services, which are the responsibility of local governments, are either underdeveloped or missing in many parts of the country due to poor capacities and local authorities’ lack of experience. In Serbia, poverty rates in the Southern and Eastern Serbia (Region Južne i Istočne Srbije) are three times higher than in the Belgrade Region (Beogradski Region). Access to infrastructure, such as public water supply, in rural areas remains an issue in most economies.

Many minority groups, such as Roma and lesbian, gay, bisexual, transgender and intersex (LGBTI) people, are still subject to discrimination. Negative stereotypes, violence or denial of access to public services and jobs leave these groups largely marginalised. In all economies, Roma have very low health coverage, lower employment rates and poor access to education, public services and infrastructure, such as piped water and electricity, particularly in rural areas. Across economies, up to half the population believed homosexuality is a sickness, and LGBTI communities often report personal experiences of harassment. Existing legal provisions to protect LGBTI rights can be strengthened, and data collection on hate crimes should be prioritised.

Figure 2.1. Western Balkan poverty rates remain comparatively high

Poverty headcount ratio at USD 5.50 per person per day (2011 PPP)

Employment opportunities are inadequate, especially for women and the young

Labour market imbalances leave many in the region without jobs. While employment rates have increased over the past decades in most Western Balkan economies, they still trail behind benchmarks economies (Figure 2.2). On the demand side, a rather slow structural transformation and economic diversification did not lead to job creation. On the supply side, Western Balkan economies struggle with skills gaps and mismatches, inadequate activation policies, inadequately designed labour laws and high labour costs.

Figure 2.2. A large share of the region’s population is not employed

Employment-to-population ratio, age 15+, total (%) (national estimate)

The region’s youth is not well integrated into labour markets, and looming demographic changes, coupled with high migration, can lead to brain drain and human capital loss. About one in four people aged 15 to 24 does not participate in education, training or employment in the Western Balkans (Figure 2.3 – Panel A). The younger generation migrates abroad primarily due to poor employment opportunities (Figure 2.3 – Panel B) but also to poor public services and environmental concerns, such as air pollution. At the same time, the wage differential with the European Union constitutes a strong pull factor. Low fertility rates throughout the region (World Bank, 2020[1]) are expected to create further demographic pressures.

Figure 2.3. High youth unemployment fuels migration

If managed well, migration can bring significant development opportunities to the region. First, already significant remittances (9.6% of regional GDP in 2019) can be better channelled to finance investments. Second, by promoting circular migration and tapping into their large diasporas, economies can attract more FDI and benefit from new skills and knowledge.

Besides youth unemployment, women’s low participation in paid work due to traditional norms and lack of care services is striking. Despite variation across Western Balkan economies, the regional gender gap in labour force participation (22.5 percentage points) is significantly higher than the OECD and EU averages (16.5 and 12.5 percentage points, respectively) (Figure 2.4).

Figure 2.4. Selected indicators of gender equality underscore that women in the Western Balkans are not yet treated equally

Across regional economies, women bear the brunt of unpaid work in the household (a main self-reported reason for labour market inactivity), and cultural norms that encourage traditional division of labour are strong. Elderly and child care social services that could free up women’s time for paid work are both underdeveloped and not well accepted. Indeed, average preschool enrolment rates in the region are very low, especially among 0- to 3-year-olds.

Women’s participation in Western Balkan societies is not yet equal along multiple other dimensions. Although far from parity, female representation in the legislative branch and in private-sector management is generally better than in OECD countries. However, in all regional economies, women’s participation in executive branch decision making is lower than men’s, and their participation at the local level is significantly lower than at the national level. There are also issues across the region concerning social norms that accept gender-based violence and skewed sex ratios at birth due to strong preferences for male children.

Attending education in the Western Balkans does not yield the skills needed to succeed

Student skills are generally low in the region, and access to education is not always equal. The OECD Programme for International Student Assessment (PISA) shows most Western Balkan economies trailing behind international benchmarks. Students from rural areas and those from minority groups are less likely to perform well. In Serbia, students attending schools in cities scored, on average, 122.3 points higher in the reading assessment than those enrolled in rural areas (OECD, 2019[5]). Roma children throughout the region are far less likely than their non-Roma peers to participate and progress in school and higher education, especially when living in poverty.

At least half the children in the region do not attend pre-primary education. Gross ECE enrolment rates in 2017 ranged from 30.5% in North Macedonia to 54.1% in Serbia (UNESCO, 2020[6]). Lack of ECE participation means that children are likely to lack foundational skills, which are integral at later stages of education, and keeps women caring for children at home out of the labour market.

Education resources, including teaching staff, are not well utilised. Despite a favourable pupil/teacher ratio overall (Figure 2.5), poor teacher selection criteria and the lack of opportunities for professional development drag down teacher motivation and affect teaching outcomes (Figure 2.6). Limited education funding does not provide adequate opportunity for teachers to take up trainings.

Figure 2.5. Favourable pupil/teacher ratios are not reflected in education outcomes

Pupil/teacher ratios at the primary, secondary and upper secondary education levels

The potential of vocational education and training (VET) can be further exploited. Western Balkan economies have relatively high secondary education enrolment rates, especially in VET. Effective VET systems can matter a great deal, yet curricula need to be more practical and better adapted to labour market needs. Programmes in most Western Balkan economies are still mainly based on theory, and there is a great need to adapt infrastructure and materials for practical learning (Maghnouj et al., 2019[8]).

Figure 2.6. Education outcomes are comparatively low in the region

Health systems are ineffective and understaffed, resulting in poor health outcomes

Promotion of healthy lifestyles is a particular challenge in economies that, in common with OECD countries, face ageing populations and a growing share of non-communicable disease burden. Adult obesity rates in the region are higher than the 19% in the average OECD country, as are smoking rates, which range from one in three men in Albania to almost one in two in North Macedonia. While child health outcomes have generally improved in the past decade, they remain a particular concern in Albania, Kosovo and North Macedonia and for children from ethnic minorities throughout the region. All economies will need to improve underdeveloped and fragmented preventative and primary health care.

Healthcare systems in the region are generally under-resourced and financially unsustainable and place high costs on patients. Health expenditure as share of GDP for several economies is much lower than the EU and OECD averages (Figure 2.7). Medication and equipment shortages particularly affect rural areas. While in the efficacy, financial sustainability and set-up of insurance systems vary (ranging from a compulsory health insurance scheme covering almost 98% of the population in Serbia to no public insurance fund in Kosovo), out-of-pocket healthcare expenditures are high throughout the Western Balkans, and a significant share of the population reports unmet medical needs. Informal payments for healthcare services, especially in public hospitals, remain common.

Figure 2.7. Health systems in the region are underfunded and place high financial burdens on patients

Especially in the face of COVID-19-related strains on health systems, the lack of medical staff throughout the region is problematic. With 2.3 doctors per 1 000 inhabitants on average, the number of doctors per capita in the region is well below the OECD and EU figures (Figure 2.8). Remote hospitals in particular, which already lack specialists, have seen hundreds of physicians and nurses migrate to work in EU countries, mainly Germany, in the last years. Some economies have launched initiatives to retain medical staff, such as a patronage programme that sends doctors to regional districts in Albania or the doubling of doctor and nurse salaries in North Macedonia. Further efforts will be needed, as the overall lack of funds and the lack of transparency in human resource management make working in public health unattractive. Expanding digitalisation and telemedicine to increase access to specialist care in remote regions is an option to consider.

Figure 2.8. Health systems lack qualified medical staff, particularly in Albania and Bosnia and Herzegovina

Practicing physicians (per 1 000 inhabitants)

Social protection needs a more sustainable financing model and does not always reach those most in need

Western Balkan social insurance systems, particularly pension funds, need to find a more sustainable financing model while fully preventing old-age poverty. Generally, social protection expenditures in the region are low by international comparison, ranging from less than 9% of GDP in Kosovo to 21.5% in Serbia in 2016, and well below the EU28 average of 28%. While it is difficult to generalise the economy-specific set-ups detailed in the assessments, they share several characteristics. Uptake of private old-age insurance is very low, and public pension outlets generally make up the largest and growing share of overall social protection spending. While pension coverage in the region is generally high (and often geared towards special-interest groups, such as war veterans), payments are too low to fully protect against old-age poverty. High informality makes financing from social security contributions difficult. All economies struggle to some degree with financial sustainability, and general government expenditure is used to prop up pension funds. In recent years, various reforms to address pension fund deficits have been implemented. In 2014, Albania removed caps on maximum benefits, linking contributions and payments to incentivise pension uptake. Kosovo is discussing the reintroduction of a pay-as-you-go pension scheme. North Macedonia switched to price indexation of pensions in 2019. Serbia introduced regulations that affected both the retirement age and the pension level from 2008 onwards.

Other social assistance schemes are limited and ineffective. Spending on social assistance makes up a very small share of overall social protection spending, ranging from 1.6% of GDP in North Macedonia to 5% in Serbia, compared to 12.1% in the EU28 in 2016. Last-resort social assistance spending makes up an even smaller share, and benefit levels are inadequate: social assistance programmes across the region only reduced the risk of poverty by 3.9%, half the reduction observed in the European Union (ESPN, 2019[12]). The need to improve the coverage, ease of access and administrative efficiency of social safety nets and to expand nearly non-existent social and labour market reintegration services and link them within the social protection ecosystem is discussed further in the specific parts of the Multi-Dimensional Review of the Western Balkans.

Prosperity

GDP growth is weaker but more balanced

Prior to the global financial crisis, most Western Balkan economies were growing strongly (at an average annual rate of 5.8% between 2001 and 2008) on the back of expanding domestic demand fuelled by credit growth from the newly privatised and largely foreign-owned banking sector and by high and rising remittances. However, in most cases, the largely consumption-driven growth was accompanied by the accumulation of significant macroeconomic imbalances, including high current account deficits (about 7% in all Western Balkan economies), accumulation of significant credit risk in the banking sector, and wage growth that outpaced productivity growth and thus negatively affected competitiveness. The global financial crisis put a wrench in the growth engines of regional economies. In particular, in the context of weak to modest progress on structural reforms and on competitiveness growth, the high credit expansion resulted in a considerable decline in GDP growth (Figure 2.9).

Figure 2.9. Growth declined considerably over the past decade due to moderating domestic demand, in line with global dynamics

Growth in the post-crisis period has become more broad based, but export performance varies across the region. Over the past decade, GDP growth has become more balanced, with a stronger contribution from external demand (Figure 2.9). This has resulted in more macroeconomic and financial-sector stability. However, exports’ contribution to GDP varies considerably across the region, with some economies, such as Albania and Kosovo, lagging significantly behind the others. Even among regional leaders North Macedonia and Serbia, export performance is significantly lower than in aspirational EU peers, whose export-led growth model led to a speedy convergence with EU income levels in the early 2000s (Figure 2.10). Last, the region still relies heavily on the export of raw materials and low-value added products, and there is considerable scope for diversification and upgrading of export baskets.

Figure 2.10. Exports’ contribution to GDP has increased across the region, but export performance varies and lags behind aspirational EU peers

Exports as a share of GDP

GDP growth and export performance are hampered by weak productivity, low investment in export-oriented sectors and weak linkages between the FDI sectors and the local economy. Labour productivity in the Western Balkans is low compared to global peers and the EU and OECD averages (Figure 2.11 – Panel A). In the post-crisis period, productivity growth weakened considerably across the region due to weak within-sector productivity growth and limited reallocation of labour from less to more productive sectors (Figure 2.11 – Panel B). While investment is moderate or high in most regional economies (Figure 2.12), a significant share goes to the non-tradable sector and/or sectors with weak productivity-enhancing potential (e.g. real estate, wholesale and retail trade). Most economies struggle to attract greenfield FDI in export-oriented sectors, while those that have been more successful (e.g. North Macedonia and Serbia) struggle to reap the productivity-boosting benefits from these investments due to the relatively weak linkages between the FDI sector and the local economy.

Figure 2.11. Labour productivity is low in the region, and productivity growth has weakened over the past decade

The structural transformation of Western Balkan economies therefore has been relatively slow, and despite some improvements in recent years, labour market outcomes remain relatively weak. Unemployment is high compared to the European Union and the OECD (15.9% vs. 6.5% and 5.8%, respectively), and employment is low (42.7% vs. 55% and 57.7%, respectively). Labour force participation lags considerably behind the EU and OECD averages. Young people are particularly strongly affected by the lack of (quality) job opportunities, a key push factor behind the high emigration from the region, particularly among the young and the highly educated.

Figure 2.12. Investment is moderate or high in most regional economies

Gross fixed capital formation (% of GDP), 2019

Looking to the 2030 horizon, Western Balkan economies need to build on their progress by continuing, and in most cases accelerating, structural reforms to increase competitiveness, boost investment and productivity growth and diversify, upgrade and expand export baskets. Reaching these objectives would require addressing common challenges.

Domestic enterprises, particularly SMEs, face a challenging institutional and business environment

While some regional economies have made more progress than others in reducing the administrative and regulatory burden on businesses and in improving their investment climates, a number of common challenges persist. Corruption remains a pervasive problem that undermines trust in public institutions and is a significant deterrent to investment. Investment is also hampered by lengthy, costly and unpredictable contract enforcement, which in most cases reflects the highly overburdened and insufficiently specialised court systems.

Businesses face an uneven playing field when operating in the region. In all economies, competition from the large informal sector constitutes the most important constraint, as evidenced by the latest Business Environment and Enterprise Performance Survey (BEEPS) results. In some economies (Bosnia and Herzegovina, Kosovo and Serbia), unfair competition also stems from SOEs, which are present in many sectors. These SOEs benefit from direct or indirect government financial support and other advantages not enjoyed by private enterprises.

Figure 2.13. The top five constraints identified by Western Balkan businesses are high informal-sector competition, high taxes, political instability, poorly educated workers and poor transport infrastructure

Share of firms identifying main constraints (%), 2019

The lack of a skilled workforce impedes the growth of investment, job creation, innovation and technology adoption

An inadequately educated workforce is an important constraint to businesses in the Western Balkans, as evidenced by BEEPS results (Figure 2.13). This constraint reflects not only the quality of the education systems but also the relevance of the education received to the needs of the market.

The quality of education in the Western Balkans lags significantly behind aspirational EU and OECD peers, according to student performance on international assessments and other indicators. In the latest PISA, fewer than 50% of Western Balkan students achieved minimum proficiency across the three subjects, compared to the OECD average of nearly 80%.

Figure 2.14. Western Balkan student performance on the PISA lags considerably behind the OECD

Share of students achieving the minimum level of proficiency (%), 2018

The region’s education systems do not impart the knowledge and skills needed by the labour markets. In the latest Balkan Barometer survey, nearly 30% of respondents noted that the education they received did not meet the needs of their jobs, and more than one-quarter identified skills they still needed to meet the needs of their jobs. Mismatched or missing skills refer not only to technical skills but also to more general cognitive skills that enable workers to solve problems, adapt, grow and innovate in the workplace (RCC, 2019[15]).

The high emigration from the region, especially of young and highly educated people, exacerbates the skills challenges companies face. Since the 1990s, more than one-third of the region’s population has emigrated, and the rate of emigration of high-skilled workers is high: 55% of the population with higher education has emigrated from Bosnia and Herzegovina, and nearly 40% has from Albania and North Macedonia (World Bank, 2020[1]).

Infrastructure gaps impede trade and global value chain integration, and unreliable access to electricity and other utilities deter investment

Deficiencies in the size and quality of infrastructure in the transport, energy and municipal infrastructure sectors vary across economies, with Albania, Bosnia and Herzegovina and Kosovo facing the biggest challenges. However, in all economies, the infrastructure sector suffers from underinvestment and insufficient maintenance by largely inefficient SOEs and from underutilisation of private-sector investment and operational potential. In the transport sector, road and railway density is considerably lower than in aspirational EU and OECD peers. Poor transport infrastructure is one of the top five constraints identified by businesses in the latest BEEPS.

All regional economies face challenges with respect to the sustainability of their energy supply. All except Albania rely on highly polluting lignite coal for most of their electricity generation, but their thermal power plants are outdated and require either costly rehabilitation or decommissioning. This limit on future supply is compounded by the high intensity of energy consumption, which is in turn fuelled by the lack of cost-reflective electricity pricing. Particularly in light of the high air pollution and the impacts of climate change, economies will need to consider diversification into more renewable energy sources.

Partnerships and financing

Western Balkan economies rely heavily on external financing for growth

In light of the weak domestic savings, Western Balkan economies rely strongly on external financing. Even though remittance income and ODA have declined considerably over the past decade, their contribution to GDP in Western Balkan economies is relatively high compared to global peers. The region is also a strong recipient of FDI relative to global peers (Figure 2.15).

Figure 2.15. With low domestic savings, Western Balkan economies rely heavily on external financing, including remittances, net ODA and FDI

Fiscal performance varies, but the fiscal space in most Western Balkan economies is limited or has narrowed considerably in the post-crisis period

Public debt is low across all economies except Albania and Montenegro but has increased in most over the past decade. Public debt expanded across the region as a result of expansionary fiscal policies in the aftermath of the global financial crisis, including the introduction, in some economies, of various fiscal incentives for investment and employment (Figure 2.16 – Panel A). In recent years, some economies, most notably Serbia, implemented fiscal consolidation to reign in the growth of public debt and to re-establish fiscal sustainability (Figure 2.16 – Panels A and B). Thanks to its strong revenue performance, Bosnia and Herzegovina has been running high fiscal surpluses throughout most of the past decade and is the only regional economy in which public debt declined (Figure 2.16 – Panel A).

Figure 2.16. Public debt is low in most regional economies but has grown in recent years as most economies ran fiscal deficits

Weak public-sector revenue performance limits the scope for improvement of public services

With the exception of Bosnia and Herzegovina and Serbia, revenue performance in Western Balkan economies lags behind global peers (Figure 2.17 – Panel A). This primarily reflects the low tax bases and the considerable tax avoidance in the large informal sectors (estimated at around 20% to 30% in most economies). All economies are also affected by significant under-reporting of wages and a high share of envelope wages, which affects the revenues from personal income tax and social security contributions. The relative underperformance of revenues also reflects the low tax rates (Figure 2.17 – Panel B) and the significant tax exemptions for investment or employment (e.g. North Macedonia, Serbia).

Figure 2.17. Revenue performance is weak in many regional economies, in part reflecting the low tax rates

2018 or latest available year

High and rising current expenditures crowd out public investment

Over the past decade, public expenditures in the Western Balkan region have been characterised by high and rising current expenditures (Figure 2.18), driven mainly by public wages and subsidies and transfers. In Bosnia and Herzegovina and Kosovo, rising expenditure pressures reflect generous benefit schemes for war veterans and high wages in oversized public sectors: public-sector wages are 38% higher than private-sector wages in Bosnia and Herzegovina (Agency for Statistics of Bosnia and Herzegovina, 2020[18]) and 43% higher in Kosovo (Kosovo Agency of Statistics, 2020[7]). In North Macedonia and Serbia, the high subsidy and transfer expenditures reflect not only high pension expenditures but also generous subsidies related to private-sector investment and employment. Large, inefficient and loss-making SOEs are an important drain on public finances in Bosnia and Herzegovina, with direct and indirect fiscal support estimated at 5% of GDP annually (Cegar and Parodi, 2019[19]).

Figure 2.18. Current expenditures are high and crowd out capital spending

High and growing spending on public-sector wages and transfers limits the space for increased spending on infrastructure, education, health and other areas of development significance. This has had important implications for the quality of infrastructure and public services, with Western Balkan economies lagging significantly behind EU and OECD aspirational peers.

The health, education and other outcomes in the region also reflect the quality of public spending. In most economies, student performance on international student assessments (Figure 2.19) or indicators of infrastructure quality are low relative to the level of public spending. Improved targeting is needed to achieve the right development outcomes.

Figure 2.19. Western Balkan PISA scores are low relative to spending on education

SMEs face considerable difficulties accessing financing

Even though all economies in the region have re-established financial-sector stability over the past decade, and the largely foreign-owned banks are generally well-capitalised, liquid and profitable, access to financing remains a major challenge, especially for micro and small enterprises and start-ups. Banks are generally able to service established SMEs and large enterprises well, but the relatively strict requirements regarding collateral (high value and preference for real estate), history of operations, turnover, profitability, etc. are difficult to meet for many SMEs, especially start-ups. In some economies, high interest rates represent a considerable barrier to financing (e.g. Albania and Kosovo), and high government borrowing from the domestic banking sector crowds out enterprise lending (e.g. Albania, Bosnia and Herzegovina). The challenge is exacerbated by the lack of alternative sources of financing, such as microfinance, capital markets and venture capital.

Peace and institutions

Western Balkan economies have not yet struck the right balance of power between levels of government

Redefining the power of subnational governments has been a crucial pillar of the process of democratisation and economic reform in the Western Balkans. The collapse of previous regimes in the 1990s created pressure for population migration from poorer to richer regions. Capital cities attracted both labour and capital, leading to large and growing regional disparities. In response, governments decentralised power to local governments: given their closer contact with citizens, they seemed better placed to provide the goods and services needed. As opportunities and talent continued amassing in capitals, the resources and fiscal capacity of increasingly autonomous peripheral areas quickly decreased (Bartlett, Kmezić and Đulić, 2018[21]).

The balance of power between central and local governments has not yet stabilised. Local governments often lack the right resources to carry out large responsibilities (Figure 2.20). This is partly due to the Eurozone crisis, which affected the region from 2009 onwards. Local governments had to deliver increasingly significant social protection policies, while tax revenues fell and central governments raided their budgets to pursue fiscal consolidation reforms, for example by squeezing intergovernmental transfers or shared taxes. Some governments have therefore returned to greater fiscal centralisation. Others have used the shrinking resources available for local development to reward local administrators from the same political party, ethnic group or kinship, with little regard to efficiency (Bartlett, Kmezić and Đulić, 2018[21]).

Figure 2.20. In most Western Balkan economies, subnational revenues may be insufficient to provide quality public services and goods

Total subnational revenues (% of GDP)

Far-reaching territorial and administrative reforms are under way in most of the region. They aim at strengthening local governments through increased political and administrative power. This could lead to more balanced territorial development only if local governments have adequate financial tools to deal with the changes, and there is meso-level co-ordination. Co-ordination mechanisms across local governments can enable joint provision of public services and allow economies of scale. By working together, neighbouring administrations are more likely to overcome common obstacles and leverage common opportunities.

Imperfectly defined land rights undermine the functioning of land markets

All Western Balkan economies, albeit to a different extent, face land rights issues. They stem from the position of landowners under socialist or communist regimes and from the liberalisation of markets in the post-socialist era. From the 1950s to the 1980s, private ownership, although heavily regulated, was widespread in the former Yugoslavian republics, while it was completely forbidden in Albania. In the 1990s, land reforms were undertaken everywhere as part of the transition to market economies. These mostly aimed at redistributing land rights based on equity principles and on historical claims from before socialism. Implementation was not smooth. Authorities could not always verify and register property ownership due to poorly maintained and outdated land registers and cadastres. As a result, individuals claiming ownership rights on the same parcel is a common problem and weighs on courts (Hartvigsen, 2013[23]).

Insufficient property rights regimes have slowed the development of land markets in the Western Balkans. Without clear ownership rights, transactions are either impossible or take place only after long and costly legal proceedings. As an alternative, many transactions take place informally, following local customs and traditions. If not regulated, this type of transaction can further complicate authorities’ mapping of land ownership and ultimately undermines the functioning of land markets. Incomplete land markets partly explain the fragmentation of land across the region. Land holdings are often small and do not allow for the large infrastructure investments and economies of scale that would increase agricultural productivity.

Major reforms have been carried out, with varying results. Success or failure often depend on the organisation (at the national and subnational levels) of the cadastral agencies, the efficiency of the judicial system (which should regulate disputes), the entrenchment and regulation of local customs and traditions, and citizen trust in formal institutions generally.

The judiciary in the Western Balkans is often biased and inefficient

Trust in the judiciary is low in the Western Balkans. Citizens often perceive courts as biased and inefficient (Figure 2.21), and only 35% have confidence in the work of the courts. Bribes, gifts and personal networks are often used to advance special interests, interfere with the normal course of justice or speed up the work of the court. Indeed, the slowness of judicial systems remains a major constraint, particularly in Bosnia and Herzegovina, Kosovo and Serbia. Biased and inefficient courts may discourage investors and push citizens to settle disputes informally, which may create confusion and misunderstandings over time. The judiciary systems seem incapable of providing checks and balances on the executive, which undermines the stability and development of democratic institutions.

Figure 2.21. Judiciary systems in the Western Balkans are perceived as biased and inefficient

Performance of Western Balkan economies along selected dimensions with respect to OECD performance

Judicial systems in the Western Balkans have three common weaknesses. First, high councils – the highest authorities, which should ensure the independence of the judiciary – are exposed directly or indirectly to external pressures. This affects their ability to select and promote judges and prosecutors based on abilities rather than political affiliations. The way in which judges and prosecutors are recruited, then, is often opaque: standard examinations are rare, and national parliaments often play a significant role in vetting candidates. Some economies also lack codes of ethics.

SOE governance is a source of large inefficiencies

SOEs have a large role in Western Balkan economies. They provide key public goods and services, particularly utilities, transport and telecommunications. SOEs often employ disproportionately large numbers of workers for the economic contribution of the enterprises. Governments, especially at the local level, may distribute jobs in public companies based on ethnic or political principles or kinships rather than skills and merit. SOEs in several Western Balkan economies (especially Bosnia and Herzegovina) offer higher wages than the rest of the public sector or the private sector, thereby distorting the labour market. Costly staffing undermines the efficiency and value of SOEs, causing them to run into debt, which ultimately weighs on taxpayers.

Significant reforms have boosted SOE performance throughout the region, but challenges remain. Governments have introduced stricter rules with respect to the disclosure of financial information and audit practices (OECD, 2018[25]). Yet, ownership remains somewhat opaque, and oversight is insufficient. This creates scope for mismanagement practices, including hiring based on personal networks. More professional boards can improve the quality of management, staff and products, with great benefits for the rest of the economy.

The EU integration process and the role of informal institutions

The prospect of accession at times plays an ambivalent role in the relationship between formal and informal institutions. To signal their commitment to the European Union to voters and the international community, governments sometimes introduce laws that are stricter than requested and hence outpace capacity. According to a regional perception survey, this practice is perceived to be particularly widespread in North Macedonia (54% of respondents), Kosovo (41%) and Bosnia and Herzegovina (39%) (Lavrič, Senjković and Klanjšek, 2019[26]). The incapacity of governments to transpose and implement laws that are too strict and the incapacity of citizens to follow them promote informal practices. In particular, citizens exploit interpersonal relationships that are well rooted in the economy's culture, traditions and history to obtain services they could not otherwise obtain. Informal practices, if not factored into the design of public policy or regulated, may weaken formal institutions and citizen trust in them. This could create a vicious circle that ultimately wears out the social contract necessary for stability.

Planet

Western Balkan economies face high levels of pollution and important challenges in their energy sectors. Air pollution levels in Western Balkan economies are the highest in Europe, and their economic and health costs are high. Inadequate management and treatment of solid waste and wastewater cause ambient and water pollution and pose a threat to human health. In the energy sector, except for Albania, Western Balkan economies rely heavily on highly polluting coal for electricity generation. Pollution, low levels of energy efficiency, an outdated energy infrastructure and an unreliable electricity supply are key challenges. Public utility tariffs set below operational costs limit the financial resources available for investments in solid waste and wastewater management, the water supply and the energy sector. Natural hazards, water management and water scarcity are further challenges in some Western Balkan economies.

Air pollution: high levels of pollution pose a threat to biodiversity, human health and the economy across the Western Balkans

Levels of air pollution are high across regional economies

While high across the region, air pollution levels are highest in Bosnia and Herzegovina and North Macedonia (Figure 2.22). North Macedonia’s annual exposure to particulate matter PM2.5 air pollution decreased from 39.1 µg/m³ in 2005 to 33 µg/m³ in 2017 but remains the worst in the region and above the World Health Organization recommended maximum level (annually) of 10 µg/m³. Belgrade, Sarajevo and Skopje are among the most polluted capitals in Europe. Low levels of energy efficiency in the residential sector, poorly insulated buildings, electricity generation from coal and the transport sector (characterised by an outdated vehicle fleet) are the main sources of air pollution in Western Balkan economies.

Air pollution poses a threat to human health, the economy and the environment. Premature deaths attributable to air pollution are high in Western Balkan economies: on average, 130.1 per 100 000 inhabitants died prematurely due to air pollution in 2016 (Figure 2.23). Air pollution negatively affects the economy through healthcare expenses and lost days at work and school.

Figure 2.22. Air pollution levels are high across Western Balkan economies

Mean exposure to PM2.5, 2017 and 2010

Figure 2.23. The mortality rate due to ambient air pollution is high in Western Balkan economies

Mortality rate attributable to household and ambient air pollution (per 100 000 inhabitants), 2016

Poor waste management and inadequate wastewater treatment are major sources of ambient and water pollution across Western Balkan economies

Solid waste and wastewater treatment is limited and a major source of pollution in the region. Waste collection services are not available everywhere, and wastewater treatment plants are scarce: 31% of the population of Bosnia and Herzegovina is connected to the public sewage system, and only 15% of wastewater is treated. Only 1% of Kosovo’s population is connected to a wastewater treatment plant, although three new plants are in development. Illegal and non-compliant landfills and dumpsites are widespread in the region. In Kosovo, 57.7% of the population is served by municipal waste collection. Solid waste and wastewater are a main source of water and ambient pollution and a threat to biodiversity and human health.

Biodiversity: the region’s rich biodiversity and abundant forest coverage is threatened by pollution and not sufficiently protected

Biodiversity in the region is threatened by pollution and needs better protection. Between 28% (Albania) and 61% (Montenegro) of economies’ territory is covered by forests. The forest sector makes an important economic contribution in many Western Balkan economies and could be further exploited. Yet, poor forest management and forest degradation pose challenges. Pollution (most importantly) and solid waste and wastewater also threaten biodiversity. Terrestrial protected areas are scarce in the region, amounting to 8.9% of the territorial area, on average, in 2018, compared to an EU average of 25.9% and an OECD average of 15.1% (Figure 2.24).

Figure 2.24. Terrestrial protected areas are scarce in Western Balkan economies

Terrestrial protected area (% of total territorial area), 2018

Energy sector: energy efficiency levels are low across Western Balkan economies, and most economies rely heavily on coal for electricity generation

Reliance on coal as the primary source of energy for electricity generation, coupled with low levels of energy efficiency, results in high levels of air pollution and greenhouse gas (GHG) emissions. The share of coal in the electricity mix ranges from 39% to 94% in Western Balkan economies other than Albania, which produces 100% of its electricity from hydropower (Figure 2.25). Except for hydropower, renewable energies are almost non-existent in the energy mix, despite their relative abundance. The high carbon intensity results in high air pollution and GHG emissions: in North Macedonia, carbon dioxide emissions from fossil fuel combustion make up almost 80% of total GHG emissions.

At the same time, energy efficiency is low in most Western Balkan economies. In 2017, the total primary energy supply per USD 1 000 of GDP in Western Balkan economies was, on average, 30% above the EU average; it was 50% above in Bosnia and Herzegovina, the worst-performing economy in the region. Electricity networks are degraded and outdated in many economies, resulting in high transmission and distribution losses (2.5 times the OECD and EU average) (Figure 2.26). Electricity supply tends to be unreliable in the region.

Figure 2.25. Western Balkan economies rely mainly on coal and hydropower for electricity generation

Electricity generation mix (%), 2018

Figure 2.26. Electric power transmission and distribution losses are high in most Western Balkan economies

Electric power transmission and distribution losses (% of output), 2014 and 2005

Governance inefficiencies: tariffs set below operational costs threaten the financial sustainability of public utilities

Public utilities are often priced below operational costs in Western Balkan economies, threatening their financial sustainability. Tariffs, including for waste collection, water and electricity, tend to be set below the cost of providing the service and too low to cover operation and maintenance expenses. Local governments are therefore required to support utility companies through transfers and subsidies, leaving insufficient resources for investments to upgrade and build new infrastructure

Water: water management, access to drinking water and water scarcity are challenges in some Western Balkan economies

Water resources are scarce in several economies, including Bosnia and Herzegovina, Kosovo and North Macedonia. With 2 100 m³ of total renewable water resources per capita per year, Kosovo has only 14% of the regional average of renewable water resources. Access to drinking water is often worse in rural areas than in cities. In Albania, the share of the population using safely managed sources of drinking water has increased from 49.3% to 70% since 2000 but remains a challenge, particularly in rural areas. Low drinking water quality is an important challenge in Serbia: 56% of drinking water in urban areas and 37% in rural areas meets minimum quality requirements.

Natural hazards: most Western Balkan economies are vulnerable to natural hazards

Western Balkan economies are most vulnerable to flooding, earthquakes, droughts, fires and landslides. Flooding poses a particular threat. In Serbia, floods in May 2014 affected 22% of the population (1.6 million people) in two-thirds of municipalities (most located in Central and Western Serbia) and caused EUR 1.5 billion in damage. Several economies, most notably Albania but also Bosnia and Herzegovina and North Macedonia, are also very vulnerable to earthquakes. A magnitude 6.3 earthquake in Albania in November 2019 affected 202 291 people, caused 51 fatalities, injured at least 913, displaced around 17 000 and was estimated to have cost close to EUR 1 billion. Extreme weather events are likely to become more frequent due to climate change.

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