Annex_1_Additional_Background.docx

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USAID/Kosovo Economic Governance Activity Annex 1: Additional Background about Development Challenges in Kosovo Kosovo’s economy is underdeveloped. Even historically, it served as an exporter of low-value-added products, and in the Yugoslav era, efforts at industrial development were limited. Stagnation of industrial production and post-war reconstruction turned Kosovo into an import-dependent economy with a very large trade deficit, financed in part through foreign assistance and remittances. Since independence, Kosovo has not structurally transformed its manufacturing or service sectors. In addition, its infrastructure was badly damaged following the dissolution of Yugoslavia and the fight for independence.

However, with partners’ support Kosovo has taken incredible strides in economic reform, demonstrating progress which, in many areas, outstrips its Western Balkan neighbors. In the last 10 years, Kosovo has made significant progress in the areas of macroeconomic stability and business regulatory reform by adopting significant formal limitations on governmental spending, streamlining and automating certain taxation processes, and reaching a rank of 40 out of 190 economies on the World Bank Doing Business Report (up from a ranking of 126 in 2012).

While these changes have had substantial effect, the rate of economic growth has not changed appreciably. It should be noted that economic growth is influenced by many factors other than a country’s public financial management and legal and regulatory environment including, for example: exogenous political obstacles, infrastructure, and education and workforce development. In addition, Kosovo’s economic reforms have taken place in a backdrop of the institutional “blank slate” the country faced post-conflict and prior to the independence process. As such, the country’s impressive progress has not resulted in the necessary economic and job growth.

Kosovo remains one of the poorest countries in Europe and its economy remains heavily consumption-led, with remittances and government expenditure accounting for approximately 40 percent of its GDP. Ninety nine percent of Kosovo’s businesses are micro, and the official unemployment rate is still hovering around 30 percent (with youth unemployment over 50 percent). In recent years, the annual GDP growth rate has typically been between 3 and 4 percent; this growth rate is simply not sufficient to address Kosovo’s high levels of unemployment in the near or medium term. The private sector’s distrust and perception of public sector corruption adversely impacts the norms and incentives that govern potential Kosovar and international investors. Kosovo’s EU SAA places additional competitive pressure on domestic firms as it requires the GOK to further open its economy to the EU.

Over the past decade, the GOK has made significant progress in establishing and consolidating governing institutions; however, in many cases, access to economic and political opportunities continue to flow through informal networks of power. This situation is beginning to change as public pressure to fight corruption grows and fiscal space for expanding patronage networks is increasingly limited. These institutional issues may explain why the perception of corruption among businesses is outsized to the incidence of corruption encountered; for example, in a recent survey among Kosovar businesses published by the American Chamber of Commerce in Kosovo, 98% of respondents identified corruption as a “very pressing” or “important” issue, while 48% reported having directly encountered a specific incidence of corruption in the course of business.

Kosovo’s statehood is contested as it still lacks official recognition by many countries, most importantly Serbia, two members of the permanent UN Security Council (Russia and China), and five members of the EU. Due to the failure of the five EU member states to recognize Kosovo, the EU as an organization has adopted a “status neutral” policy toward Kosovo, although the EU maintains a large presence and is the largest provider of external aid. It has not gained membership in the United Nations (U.N.) due to strong Russian objections. Kosovo’s exclusion from international organizations on the basis of this political dispute undermines its sovereignty and creates counter incentives for reform; for example, to date Kosovo has made limited effort to advance its status in the WTO, where accession essentially requires a consensus among all members (including Russia). In addition, this uncertainty has created windows of opportunity for external influence from other regional powers, such as Turkey.

In addition, Kosovo continues to demonstrate dependence on international actors like the EU, U.S., and North Atlantic Treaty Organization (NATO). The historical role of international development partners has been significant in all the critical junctures of postwar Kosovo; however, this dependence has in some instances hampered Kosovo’s long-term stability and development. This dependence is only amplified by the country’s need for economic integration due to the small size of its domestic market and the resulting inability to achieve meaningful economies of scale. While international influence in the region remains relatively high, major international actors like the EU and U.S. are dealing with other global crises, which have shifted attention and resources away from Kosovo. Although Kosovo remains an international priority to its partners, the importance of sustainable development institutions and an established path to self-reliance have only increased in today’s environment.

Alongside these contemporary challenges, a new opportunity has developed: USAID’s recent Political Economy Analysis (PEA) of Kosovo identified a shift in the populace’s mindset as arguably the most promising sign of change in the country today. The population has increasingly begun to demonstrate impatience and frustration with abuses of power and insufficient progress in economic and governance reforms. Thus, coinciding with Kosovo’s significant contemporary development challenges is a significant opportunity to capitalize and build upon the existing demand to improve the transparency and accountability of governmental economic processes, thereby eliminating avenues of potential corruption and increasing people’s faith in Kosovo’s democratic governance and economy.

Indeed, even as enthusiasm for EU integration and accession has waned in some other Western Balkan countries, it continues to enjoy overwhelming support in Kosovo.[footnoteRef:1] Despite that enthusiasm, Kosovo faces significant challenges in its path to the EU, as is reflected in the EU’s recently released strategy for “A credible enlargement perspective for and enhanced EU engagement with the Western Balkans.” That strategy lays out specific reforms required to meet EU membership criteria, with a particular focus on the rule of law, fundamental rights, and governance. A strong, independent society is required to implement these reforms - and without economic growth and opportunity, Kosovo will not see the political and democratic progress envisioned by the Western Balkans strategy.[footnoteRef:2] [1: See the RCC’s Balkan Barometer of 2017, where 90% of Kosovo respondents identified EU membership as a “Good thing,” in contrast to 42% of overall respondents in Southeast Europe.] [2: See Interview with Dušan Reljić, Head of Brussels Office, German Institute for International and Security Affairs (SWP), https://europeanwesternbalkans.com/2018/02/15/ewb-interview-reljic-no-political-progress-region-without-economic-growth/.]

As a country with geographic, political, and economic challenges, Kosovo starts with a significant disadvantage in the competition for investment. It is all the more important, therefore, for Kosovo to demonstrate commitment to meeting its obligations under the SAA and progress towards integration with other international institutions which promote good governance and a hostile environment for corruption, such as the WTO. Doing so will create the conditions for businesses to grow and prosper.