This Selected Issues paper examines the risks and structural weaknesses in Bosnia and Herzegovina. The paper provides an estimate of the current account adjustment required to stabilize net foreign liabilities. It uses the external sustainability approach of the Consultative Group on Exchange Rate Issues (CGER) methodology for exchange rate assessment. The paper analyzes the impact of the newly introduced borrowing rules on the longer-term debt dynamics. An overview of salient facts about unemployment in Bosnia and Herzegovina is also presented.

Abstract

This Selected Issues paper examines the risks and structural weaknesses in Bosnia and Herzegovina. The paper provides an estimate of the current account adjustment required to stabilize net foreign liabilities. It uses the external sustainability approach of the Consultative Group on Exchange Rate Issues (CGER) methodology for exchange rate assessment. The paper analyzes the impact of the newly introduced borrowing rules on the longer-term debt dynamics. An overview of salient facts about unemployment in Bosnia and Herzegovina is also presented.

V. An Assessment of Economic Cohesion22

Promoting economic cohesion in Bosnia & Herzegovina has been a key objective of both the International Community and the domestic authorities. Creating a single economic space makes sense in a small country like Bosnia & Herzegovina. It can also help efforts to nurture country-level identity and entrench peace and stability.

This paper examines the degree of economic cohesion in Bosnia & Herzegovina along two dimensions: (i) the degree of convergence of economic outcomes between the Entities and within the Federation, and (ii) the degree of economic integration between the Entities.

Evidence of economic convergence between the Entities is strong. This convergence has been driven by the Republika Srpska catching-up with the Federation. Alongside, the Republika Srpska appears to have fostered competitive advantages over the Federation.

By contrast, there is little evidence of economic convergence among the cantons in the Federation.

There is also little evidence of increased economic integration between the Entities, or within the Federation. Persistent unemployment differentials suggest that labor mobility is especially low, even across the cantons.

While there has been progress in harmonizing legislation and institutions at the country level, significant barriers to economic integration remain. These include a lack of portability of pension rights and health care insurance.

Improving economic cohesion in Bosnia & Herzegovina requires accelerating structural reforms in the Federation and eliminating remaining barriers to capital and labor mobility within and between the Entities.

A. Introduction

97. Promoting economic cohesion in Bosnia & Herzegovina has been a key objective of both the International Community and the domestic authorities. Creating a single economic space makes sense in a small country like Bosnia & Herzegovina because it provides unfettered access to capital, labor, and product markets thereby supporting domestic production of goods and services that are competitive on the local and international markets. It can also help efforts to nurture country-level identity and entrench peace and stability.

98. This Chapter assesses the degree of economic cohesion in Bosnia & Herzegovina along two dimensions: (i) the degree of convergence of economic outcomes between the Entities and within the Federation, and (ii) the degree of economic integration between the Entities. Economic convergence refers to the closing of differences and ultimately the equalization of economic variables like income and prices, whereas economic integration refers to the merging of economic processes and markets of different regions into a single whole. These concepts will be recognizable to readers familiar with the economic prerogatives of the EU.

B. Evidence of Economic Convergence

99. The degree of economic convergence between the Entities, and within the Federation, is examined across several variables: per capita GDP, price levels, net wage levels, and industrial production growth. There is strong evidence of economic convergence between the Entities across all variables. By contrast, there is weak evidence of economic convergence among cantons in the Federation.

Strong Entity convergence

100. As shown in Figure 1, Republika Srpska (RS) has been catching up with the Federation over the past several years.

  • Large differences in per capita GDP have narrowed;

  • Basic goods prices are now typically the same in both Entities;

  • The gap between average net wages in the RS and Federation have substantially narrowed, though net wages have typically remained higher in the Federation; and

  • After a period of divergence, industrial production level in the RS has caught up with that in the Federation.

Figure 1.
Figure 1.

Bosnia & Herzegovina: Entity Convergence

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A005

Sources: Authorities and IMF Staff calculations
Figure 2.
Figure 2.

Bosnia & Herzegovina: Entity Convergence

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A005

Bosnia & Herzegovina: ULCs, and Financial Deepening

101. Alongside, the RS has gained competitiveness relative to the Federation. Unit labor costs in the RS are substantially lower than in the Federation (see Figure 2a) because increases in the wage bill have been kept in line with output growth. This picture is further supported by OECD analysis which shows the RS having a competitive advantage over the Federation across a range of indicators.23

102. Data on financial deepening is also consistent with this picture of economic convergence between the Entities (see Figures 2b and 2c). The differences in the degree of financial deepening have begun to narrow recently. The remaining substantial differences in financial deepening between the Entities are though something of a puzzle.

Weak convergence within the Federation

103. The apparent economic convergence between the Entities stands in contrast to the picture within the Federation: available data suggest there has been very little convergence among the cantons.24

Figure 3.
Figure 3.

Desriptive Statistics for Cantons

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A005

104. In fact, economic disparities among the cantons appear to have grown across a range of indicators. As shown in Figure 3, the gap between the best and the worst performing canton increased between 2001 and 2005 across almost all indicators. Moreover, there appears to have been a generalized increase in the differences between economic performance of the cantons over this period. This can be seen in Figure 3 by the increase in the standard deviation (or variance) of economic performance of cantons relative to the average cantonal performance. The exception is that differences in the purchasing power of an average wage have narrowed slightly.25 This is perhaps in part explained by efforts to equalize public sector pay across lower levels of government in the Federation.

Figure 4.
Figure 4.

Bosnia & Herzegovina: Unemployment

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A005

Sources: Authorities and IMF Staff calculations

C. Evidence of Economic Integration

105. At root, economic integration depends on the mobility of factors of production within an economic space.26 The available evidence suggest that the Entities are not economically integrated. The strong economic convergence noted above simply reflects the relative strengthening of the RS economy alongside minimal interaction between the Entities.

Labor mobility

106. There are no direct measures of labor mobility available in Bosnia & Herzegovina. Inferences can though be drawn from data on unemployment:

  • Evidence of increasing differences in registered unemployment rates between the Entities point to low labor mobility. As shown in Figure 4a, registered unemployment rates appear to be much lower in the Republika Srpska than in the Federation.27 Moreover, the trends in registered unemployment in the Federation and the Republika Srpska have been moving in opposite directions. While some divergence can be expected because of differences in the pace and nature of structural reforms, these differences would be expected to narrow overtime as workers find employment in the Entity with less excess labor supply. There appears little evidence, to date, that this has occurred in Bosnia & Herzegovina.28

  • Evidence of persistent differences in unemployment rates across cantons is also consistent with this picture of low labor mobility, see Figures 4b and 4c. These figures show the correlation between unemployment levels at two points in time: accordingly, an upward sloping line means that higher unemployment in an earlier period is associated with higher unemployment in the later period. As the figures make clear, such a relationship emerges from the cantonal unemployment data: cantons with relatively higher unemployment in 2003 tend to be the same cantons with higher unemployment in 2005. Even viewed over a longer period (from 2001 to 2005), this pattern appears to hold.

Capital mobility

107. There has been a steady increase in the number of companies with headquarters in the Federation or the RS that have established branch offices in the other Entity.29 This picture is in principle consistent with two different explanations: one is that capital mobility is increasing; the other is that such cross-border activity reflects the contortions needed to overcome legal and institutional barriers when conducting inter-Entity commerce. We are unable to distinguish between these two explanations given the available data. Anecdotal evidence, however, suggests that the latter explanation should not be discounted.30

Figure 5.
Figure 5.

Company Mobility

Citation: IMF Staff Country Reports 2007, 269; 10.5089/9781451804942.002.A005

D. Institutional and Legislative Barriers to Integration

108. As part of the effort to create a single economic space in Bosnia & Herzegovina, significant progress has been made in harmonizing legislation and institutions between the Entities. A single currency has become an accepted means of payment throughout the country, facilitating inter-Entity transactions. Harmonized customs rules and duties are now applied at all points of entry to Bosnia & Herzegovina and a country-wide VAT has replaced an unharmonized domestic sales tax, facilitating price transparency beneficial to both consumers and producers. Modern and harmonized bankruptcy laws have also been adopted. Bank deposit holders are insured by a single and country-wide deposit insurance agency that, together with the establishment of a country-wide banking system, has aided the efficient investment of domestic savings, regardless of their geographic origin.

109. Nevertheless, significant institutional and legislative barriers to economic integration remain. There is little portability of pensions rights and health care insurance. Capital mobility is affected by varying and non-transparent property rights. The costs and procedures of doing business differ across the Entities because of varying degrees of red tape. While financial intermediation has deepened, there is still no single banking supervisor. And a host of industry-level legislation and labor regulations remain Entity specific.

E. Conclusions

110. The RS appears to be catching-up in economic terms with the Federation. This may in part reflect the implementation of delayed reforms the RS. But it is now reforming faster and has fostered competitive advantages over the Federation that herald the prospect of it pulling ahead of the Federation in the coming years. The apparent lack of economic integration between the Entities underscores this prospect. Promoting internal economic cohesion in Bosnia & Herzegovina will require accelerating structural reforms in the Federation and eliminating the remaining barriers to capital and labor mobility within and between the Entities.

22

Prepared by Graham Slack with the assistance of Irena Jankulov.

23

OECD Investment Reform Index 2006: Progress in Policy Reforms to Improve the Investment Climate in South East Europe.

24

Data constraints mean it is not possible to compile identical indicators of convergence for the cantons and Entities.

25

This is measured as the cantonal net wage relative to the average price of the basket of necessary goods in the same canton.

26

Traditional neoclassical growth models predict that, other things equal, economic convergence and integration occur through mobility of factors of production—capital and labor. Regions with a relatively high capital-to-labor ratio will, under this model, experience a net inflow of labor because the marginal value added per worker and hence wage rates are relatively high. Conversely, regions with low capital-to-labor ratios will tend to experience a net inflow of capital as marginal returns on capital investment are relatively high. This process is often stymied however by barriers to factor mobility and self-reinforcing growth which attracts net inflows of both capital and labor.

27

The 2006 Labor Force Survey also shows large differences in unemployment rates between the Entities: youth unemployment was 52.4 percent in the RS and 66.7 percent in the Federation; and male youth unemployment was 48.7 percent in the RS and 65.2 percent in the Federation.

28

The deep socio-economic and political factors affecting labor mobility in Bosnia & Herzegovina are discussed in Chapter IV.

29

Data on inter-entity investment would provide a more direct measure of capital mobility, but such data are not available.

30

At the Foreign Investors Council (FIC) conference in Sarajevo on April 24, 2007, a FIC representative observed that “without a physical presence in both Entities it is more difficult for a company to conduct inter-Entity business than it is to undertake trade with a foreign country.”

Bosnia and Herzegovina: Selected Issues
Author: International Monetary Fund