The Tragic Economy of Bosnia & Herzegovina

This is Bosnia and Herzegovina, a nation that is home to perhaps the darkest geopolitical

backstory in all of Europe, which is saying a lot. For many, the all too recent memories

of conflict represent the high cost of independence from the Socialist Federation of Yugoslavia,

a large state in the western Balkans that no longer exists. The end of the conflict in 1995

triggered the beginning of a colossal economic recovery effort, which not only sought to physically

rebuild Bosnia and Herzegovina, but also sought to restructure the economy away from centralized

free markets. Almost 30 years on and the nation has transitioned from socialism to capitalism

with mixed success. Now an upper middle income economy, Bosnia and Herzegovina is experiencing

robust growth in tourism, energy production and metal manufacturing whilst maintaining low

levels of public debt and high capital reserves within its banks. What's more, the country has

had a clear goal to work towards having been formally granted candidate status for the European

Union in 2022. This is potentially a win-win situation, with Bosnia and Herzegovina benefiting

from increased confidence, market access and participation in supply chains, whilst the EU

manages geopolitical risks by befriending a nation with a significant pro-Russia cohort in its

population. But regardless of its relationship with the EU, Bosnia and Herzegovina has a number

of deeply rooted challenges, which have, if anything, worsened since becoming an independent

state following the war. Ineffective governance, chronic unemployment and a steadily declining

population are adding tension to a nation divided by ethnic lines, who, it is felt by many,

are still not reconciled its difficult history. So, how did the newly independent nation bounce

back from war and genocide? Why has the economic development of Bosnia and Herzegovina stagnated?

And finally, what opportunities and challenges lie ahead for the nation? After we've done all

of that, we can put Bosnia and Herzegovina on the Economics Explained Leaderboard.

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For better or more likely worse, it's impossible to understand the modern economy of Bosnia and

Herzegovina without at least a cursory understanding of its all too recent history. In the late 1980s

and early 1990s, a wave of national sentiment rose across Yugoslavia which consisted of six

federations with their own cultures and identities. After Slovenia and Croatia broke away from Yugoslavia,

Bosnia and Herzegovina held an independence referendum in 1992. The outcome was in favour

of independence which was largely welcomed by Bosniaks and Bosnian Croats but rejected by

Yugoslavia and Bosnian Serbs who made up 33% of the population. Conflict broke out shortly after as

the different ethnic factions fought for territory in an escalating struggle that eventually led to

NATO bombing and UN peacekeeper troop deployment. In total almost 100,000 people died, 2.2 million

people were displaced and GDP declined by 84%. After international efforts for a peaceful solution,

the war ended in 1995 with the signing of the Dayton Agreement and Wright-Patterson Air Force Base

in Ohio USA and it's this agreement which founded the modern politics and economic powers of Bosnia

and Herzegovina to this day. Obviously that's the incredibly oversimplified summary of an endlessly

complex issue but the takeaway was that this was a bad set of circumstances to begin the process

of nation building especially since a lot of these core issues never truly went away. Founded on a

compromise in power sharing, the Dayton Agreement effectively split the state into two geographically

separate entities. The Federation of Bosnia and Herzegovina in the central, south and west of the

state which is controlled by the Bosniaks and the Bosnian Croats and the Republic Serbs go in the

north and the east of the state controlled by the Bosnian Serbs. Because of the Dayton Agreement,

power in Bosnia and Herzegovina is highly decentralized with both of these entities in

complete control of their own tax collection, public spending, development policies and welfare

programs. The only economic powers that lie at a state level are monetary policy which is managed

by the central bank, foreign trade policy and macroeconomic coordination. This level of decentralization

for a relatively small country is what makes Bosnia and Herzegovina unique and it was a requirement

for the piece that was desperately needed to enable the economic recovery that followed. It took

until 2003 for the GDP of the nation to eventually recover back to levels last seen in 1990 requiring

an average annual growth rate of 22% following the end of the war. And yes, much of this growth

derives from redeployment of huge spare capacity in the labour market but even when these factors

are accounted for there's no denying that a 22% average annual growth rate over almost an entire

decade is an impressive feat. So how did this recovery actually happen? In the first years of

peace a lot of the recovery can of course be attributed to the vast sums of post-war foreign

aid that Bosnia and Herzegovina receive from the international community for reconstruction of

damaged and destroyed infrastructure which includes $5.1 billion from the World Bank, the EU

and partner donors. As time went on however the economic growth became increasingly driven by

the pro-capitalist reforms that constituted the nation's transition from market socialism to

private enterprise. To be clear this transition of economic systems was not as extreme as other

countries across central and eastern Europe following the collapse of the Berlin Wall and the

dissolution of the USSR. As part of Yugoslavia Bosnia and Herzegovina was already using free

markets to allocate production and exchange with enterprises either being state-owned or

worker-owned and managed. In the later half of the 1990s and early 2000s large state-owned

enterprises started to be privatised which signalled opportunity to European banks who

started to provide liquidity and management expertise to the country's newly reformed banking

sector. Insolvent banks were closed, state-owned banks were privatised and new regulatory framework

was introduced to drive return on investment and manage systemic risk. Additional private property

laws were also introduced alongside the establishment of key institutions such as

two stock exchanges and the central bank. After the war many different currencies were circulating

with no generally accepted standard of payment and so a key factor of the recovery was the

introduction of a new currency the convertible mark in 1998. Not only did it standardise the

monetary system but it also generated financial stability since it was pegged to the Deutsche

Mark and eventually the Euro in 1999. A currency as payment has a fixed exchange rate to another

currency. The value of the currency is not affected by supply and demand in the foreign

exchange market against the peg because the central bank cancels out large movements by

counteracting the market when it needs to using its reserve holdings of both currencies.

When there's excess demand for the domestic currency on the market the central bank will

sell some of this domestic currency reserve to match the success. On the other hand if there's

excess supply of the domestic currency on the market the central bank will buy the excess using

its reserves of the peg currency. This ensures balance in the markets preventing the currency

from deviating from the currency it's pegged to and as a result the Bosnian Herzegovina economy

benefits from the stability that the Euroback currency brings. Now it's worth noting that peg

currencies don't always work in practice and there is some risk involved. Take for example the

Russian ruble in 1998 which was pegged to the US dollar. Investors were selling the ruble hard and

fast which forced the central bank of Russia to buy the ruble using US dollars to defend its currency

value. After selling 27 billion of its US dollar reserves in under a year the central bank ran

out of US dollars and the peg finally broke. The ruble devalued by two-thirds in just over a month

which meant the price of import a good sword causing inflation and huge drops in real living

standards. So far however the Bosnian Herzegovina and central bank has successfully maintained

the pegged exchange rate which has fostered confidence in the currency and attracted significant

amounts of foreign investment. This rewrote the nation's narrative from one of post-war recovery

to one of rapid modernization and development. The large inflows of foreign direct investment

generated employment improved infrastructure and helped to establish key export sectors in the

national economy such as electricity and metal manufacturing. This was a pretty standard and

promising development path for a country with close access to both markets in the east and the west

but it didn't last forever. Fast forward to the present day and foreign direct investment

still makes up a huge portion of the economy in Bosnia and Herzegovina particularly in banking

and manufacturing. The latest statistics value the total stock of FDI to be worth about 9.3 billion

US dollars. However net inflows decreased significantly after the 2008 financial crisis which like so

many other nations appears to be a turning point for the trajectory of the economy.

Private investment from within the country has not picked up this slack either and the reason for

this is that Bosnia and Herzegovina has some of the highest administrative burdens for business

not just across Europe but across the entire world. In 2020 the World Bank found that there are only

six countries in the world where registering a new business is more difficult. The country is also

ranked 173rd for ease of doing business with construction permits and 141st for paying taxes.

Although most recent data is a few years old now and the country ranks slightly better for other

ease of doing business metrics this is clearly discouraging for both foreign and domestic

investors who may not have the time and legal know-how to properly administer their business

operations in such a complicated regulatory framework. This explains why Bosnia and Herzegovina

has a large informal economy which is a whole other problem itself. These issues are largely

caused by the political system within Bosnia and Herzegovina which to put it frankly is overly

complex, fragmented and ineffective at taking action to drive economic development. While the

date and agreement was heralded as a success story of international peace brokering in the

modern era during the 1990s you were thinking ahead to the implications that power sharing

would have on the overall functioning of the government in the long term once this piece was

achieved. The political complexity begins right at the top with a tripartite political leadership

structure. Every four years three presidents are elected who represent each of the ethnic

constituents of the nation Bosniaks, Bosnia Croats and Bosnia Serbs. These three presidents rotate

every eight months until the four year term is over and each one has veto power to block decisions

which they believe are against the interests of their ethnic group. This high degree of power

sharing has embedded political friction into the government from the top down preventing

political solutions and slowing the legislative process. So whilst this political structure

has undoubtedly helped sustain peace it has created an ineffective government that's unable

to foster entrepreneurship. This has reduced investment causing spare capacity in the labour

marker where the unemployment rate is 10.7%. This has dropped significantly since 2015 where the

rate was 27.7%. Taking these statistics at face value you might think the declining unemployment

rate would be a positive sign but the reality for Bosnia and Herzegovina is that this has been

driven by a shrinking labour force as working age adults leave the country to find employment elsewhere.

The scale of the issue is demonstrated by the fact that Bosnia and Herzegovina has one of the

largest emigrant to population ratios in the world causing a reliance on remittances for

economic growth rather than investment into its own economy. Perhaps even more concerningly emigration

is leading to population decline with the total population having already decreased by 23% since

2000. So given such a steep decline of fundamental economic factors is there any hope for the future?

In order to reverse or at the very least slow the exodus of productive workers Bosnia and Herzegovina

needs to improve its economic offer to its citizens by increasing the quality and quantity of jobs

available. Ask most macroeconomists and they will say that investment is the key to achieving this.

Fortunately for the nation there looks to be capacity for ramping this up. Currently the capital

adequacy ratio of the banking sector which controls the level of risk and the ability to protect

depositors sits at 19.5%. This is well above the regulatory minimum of 12% which means the

domestic banking sector could increase long-term funding to key growth areas in the economy such

as energy, metal manufacturing and IT. To do this however three things need to happen. First the

discouragingly high administrative burdens of operating a business need to be reduced to

incentivise entrepreneurship. Some efforts have already been taken to address this through the

digitisation of tax filing and customs declarations for trade but more widespread reforms are needed

to significantly reduce administration and encourage entrepreneurship. Secondly corruption

in the political system in the banking sector needs to be addressed in order for capital to be

more effectively deployed in the economy. Thirdly the government must ensure that state-owned enterprises

and public sector spending are not crowding out private investment. This final point is particularly

important since the state is a huge economic power with fiscal revenues making up 44% of GDP

and state-owned enterprises having a presence larger than they do in any other country in the

western Balkans. Clearly Bosnia and Herzegovina's transition to a market economy only went so far

with the state still having significant ownership states in over 550 enterprises.

This is also likely to be an important point of future discussions on advancing its membership

prospects with the European Union. This represents a historic opportunity for the nation that would

increase confidence and enable more participation and value added supply chains. So far the nation

has made good progress towards EU integration since becoming a candidate in 2022 especially having

introduced new anti-corruption laws. In light of this progress the European Commission has

recommended that advanced negotiations begin with Bosnia and Herzegovina to plan and agree on a pathway

to its full membership. While this is promising it's not likely that the nation will become a

member for many years to come. It took Croatia eight years from this stage to become a member

whilst Turkey has been in negotiations for almost 20 years. Point being there's no guarantee of

becoming a member once the nation gets to this stage and with the range of political and economic

challenges that Bosnia and Herzegovina possesses the weight could be won to test the limits of

political patience. What's more is that EU membership alone will not fix the country's

issues. Just ask Greece Spain and Portugal. Bosnia and Herzegovina has immense potential

but it has to do more than just strive for compromise to get there.

Okay now it's time to put Bosnia and Herzegovina on the Economics Explained National Leaderboard.

In terms of size Bosnia and Herzegovina has a GDP of 27 billion US dollars which means

most national economies are larger. It ranks amongst Trinidad and Tobago and Zimbabwe giving

it a 2 out of 10. That is spread across a population of 3.2 million people which means the GDP per

capita is 8,426 US dollars which puts it below the global average and a long way away from the EU

average giving the economy a 4 out of 10. Stability and confidence is a mixed picture. While the

central bank has maintained the currency peg with the euro and the public debt levels are low the

declining population and ineffective government are weakening the confidence in the economy.

On top of this ethnic divisions are beginning to stir up again as political leaders from the Serb

territory of the nation increasingly challenge the legitimacy of the central government and call

for their own independence. In light of this it gets a 5 out of 10. Growth is steady averaging 3%

since 2000 but it is all bit stagnated since the 2008 financial crisis so it gets a 5 out of 10.

And finally industry. Bosnia and Herzegovina has a solid manufacturing base especially in metal

and electricity production. However the economy remains a net importer and there is room to

further develop its industry and increase productivity and exports. It gets a 4 out of 10.

Overall this gives Bosnia and Herzegovina an average score of 4 out of 10 putting it down here on

the leaderboard. If you liked this video then you'll also like the video we did on the economy of

Turkey which covers similar themes of how different political and economic systems affect production,

inequality and growth.