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The IMF, the World Bank,

and Economic Policy in Bosnia:


a Preliminary Assessment

David Woodward

An Oxfam Working Paper


©OxfamGB1998

First published by Oxfam GB 1998.

ISBN 0 85598 396 5

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Contents

PREFACE 4 DILEMMAS
1 Political conditionality 27
INTRODUCTION 5 9 The Central Bank as currency board 34
3 Inter-regional inequality and transfers 38
A. POLITICAL AND ECONOMIC BACK 4 How to privatise in the federation? 43
GROUND 7 5 Free entry for foreign banks? 47
Al The war and its consequences 7 6 Trade policy 48
A2 Political structures under the Dayton 7 Labour market deregulation 50
Agreement 9 8 Cost recovery 52
A3 The pre-war economy 11 9 Employment creation and the economic
A4 Recent economic developments in the strategy 57
Former Yugoslavia 12 10 Reintegration or partition? 70

B. THE IMF, THE WORLD BANK AND BOXES


ECONOMIC POLICY 14 1 Economic and social effects of the war 15
Bl The constraints on economic policy 14 2 Divergent views on BH accession to the
B2 The debt dimension 18 European Union 24
B3 IMF and World Bank relations with the 3 Prospects for the industrial sector 40
authorities 20
FIGURES
C. DONOR-RELATED ISSUES 25 1 The political structure 10
Cl Disbursement delays 25 2 Ethnic distribution of aid projects in
C2 Political conditionality 27 implementation, October 1996 30
C3 The distribution of donor funding 29
C4 Donor coordination and NGOs 31 TABLES
1 Composition of production and employ
D. ECONOMIC POLICIES 32 ment in pre-1991 Yugoslavia 11
Dl The Central Bank as currency board 32 2 World Bank programmes in Bosnia and
D2 Public finances 35 Herzegovina 21
D3 Privatisation and the settlement of 3 Pledges, commitments, project
domestic liabilities 39 implementation and disbursements by
D4 Private sector development 45 donors, October 1996 26
D5 Financial sector rehabilitation 46 4 Financial requirements, commitments
D6 Trade policy 47 and project implementation by sectors,
D7 Labour market deregulation 50 October 1996 29
D8 Utilities and public services 52 5 Regional economic indicators, 1996 37
D9 Agricultural policies 53 6 Estimated number of pensioners relative
to population and labour indicators 59
E. SOCIAL DIMENSIONS 55 7 Pensions at alternative levels of unemploy
E1 Employment and the Emergency Social ment and real wages 62
Fund 55 8 Wage contributions required for minimum
E2 Pensions and benefits 59 unemployment benefit coverage 63
E3 Health and education 64 9 Wage contributions required to restore pre-
war per capita expenditure on health 65
F. CONCLUSION 68 10 Wage contributions required for
minimum pensions, unemployment
benefits and health expenditure 66
Preface

This paper was written during the first quarter excellent translation; to Indir Kurtovic for his
of 1997, on the basis of a visit to Bosnia in patience and endurance during our longer-
January of that year. Unfortunately, it has not than-expected drive from Banja Luka to
been possible to up-date the draft since. In Zagreb; and to all of Oxfam's staff in Sarajevo
view of the rapidly evolving situation, this for their exceptional friendliness and hospitali-
inevitably means that it is likely to be some- ty. I would also like to thank all those who
what dated in parts. Hopefully, it will nonethe- generously spared their time to meet me in
less be of some use in helping to understand Sarajevo and Banja Luka.
the economic issues and policy dilemmas in It should be emphasised that the views
Bosnia. expressed in the paper are those of the
I am very grateful to all those in Oxford author, and should in no way be attributed to
and Sarajevo (and in Banja Luka and Bijeljina) Oxfam.
who helped in the planning, preparation and
execution of my visit to Bosnia. I am particu- David Woodward
larly grateful to Marijana Aksin-Macak for her December 1997
Introduction

This paper is the second in a series of studies As a result of this, and of the complexity of the
being commissioned by Oxfam on the role of the economic and political constraints, the paper
IMF and the World Bank in economic policy- concentrates on identifying a number of
making in post-conflict situations. Like the first dilemmas in economic and donor policies,
paper on Rwanda (Woodward, 1996), it rather than on making alternative proposals.
considers the economic effectiveness of the There are no simple answers in BH, and
proposed strategy, its potential social impact whatever course is chosen is likely to raise as
and the implications for the achievement of a many problems as it resolves.
viable solution to the political problems of The paper begins with an outline of the
Bosnia and Herzegovina (BH) in the long term. political and economic situation of BH. The key
This paper is more preliminary than that on political, economic and social constraints on
Rwanda. This partly reflects the current policy are set out, and the current relations
political situation: the author's visit to BH took between the IMF, the World Bank and the
place a little over a year after the end of the war various authorities are discussed in Part B. This
and the signature of the Dayton Agreement, includes an assessment of BH's debt situation,
which established the framework for a com- and the prospects for a satisfactory solution. A
pletely new political structure, and just four discussion of various donor-driven problems,
months after the September elections, which such as delays in disbursements and political
effectively started the process of forming most of conditionality, follows in Part C. Part D contains
the new institutions. As a result, the institutions an extended discussion of the policy proposals
of government are less well-established; and the currently envisaged, in terms of their economic
emphasis is primarily on reconstruction and viability, social impact and political implications.
institution-building rather than on the consid- Part E assesses the social dimensions of econ-
eration and development of detailed economic omic policy. The Conclusion seeks to draw
policies for the long term. together the diverse threads of the paper.
6
A. Political and economic background

A.I The war and its least passive collaboration with the Ustasa
consequences1 regime, or joining the partisans. Inevitably,
most chose the quiet life, leading Serb nation-
Prior to 1991, Yugoslavia was a federation, alists to identify Croats with the Ustasas, and to
consisting of six republics (of which BH was one) see Muslims as collaborators. These caricatures
and two autonomous territories (Kosovo and were revived and accentuated by nationalist
Vojvodina) within Serbia. Decision-making was propaganda in the 1980s.
very decentralised under the 1974 Constitution, The revival of nationalism, actively promoted
and at the central level each republic and by (often crude) media propaganda, culminated
autonomous territory had one representative in the break-up of Yugoslavia in the early 1990s;
on a collective presidency. Central controland and it was this process which led to the war in
coordination were maintained by the personal Bosnia, starting in 1991. However, the conflict
authority of Tito, leaving a serious power in Bosnia, more than any other part of the
vacuum following his death in 1980. former Yugoslavia, arose primarily as a result of
The result was increasing incohesion within forces external to the Republic itself. It is ironic
the Federation through the 1980s, and the that it was here that the war was longest and
reawakening (and political exploitation) of rival bloodiest.
nationalisms and historical resentments. These The process of disintegration began in earnest
arose primarily from Yugoslavia's traumatic when the Serb nationalist Slobodan Milosevic
experience during the Second World War,2 manoeuvred himself into power in Serbia on a
when the Nazis brought the extreme Croat tide of populist nationalism. Once in power, he
nationalist Ustasas back from exile in Italy and proceeded to expand the power of Serbia within
installed them in power in part of Croatia and the then Federal Republic of Yugoslavia. By
the whole of Bosnia-Herzegovina (BH). The fomenting Serb nationalism, he succeeded in
Ustasas 'were terrorists who had overnight been ousting the existing authorities in the two auton-
handed total power' (Bennett, 1995, p43), and omous territories (Vojvodina and Kosovo),
they had as a primary objective a virtual installing his own supporters in their place.
genocide of the Croatian Serbs. 'The objective, Together with the pro-Serbian Montenegro
somewhat crudely but not incorrectly stated, authorities, this gave Milosevic effective control
was to convert one-third of Orthodox Serbs into over four of the eight votes on the collective
Catholics, to expel another third to Serbia, and presidency.
to exterminate the rest' (Crnobrnja, 1996, p65). Slovenia and Croatia became seriously
Estimates of the number of Croatian Serbs killed concerned at the increase in Serbian power, and
vary enormously between Serb and Croat the extreme Serb nationalism which underlay it.
sources. The more methodical estimates suggest The Slovenian authorities ultimately responded
a figure in the order of 300,000. by declaring independence, and, after a brief
Opposition to the Ustasa regime came attempt by the Yugoslav national army (JNA) to
primarily from Tito's partisans (who were force them back into line, achieved it. Croatia
Yugoslav in orientation, and came from all quickly followed suit, motivated partly by
ethnic groups, although the greatest number Serbia's still stronger position in the Federal
were Serbs); and the Serb nationalist Cetniks. institutions in Slovenia's absence; partly by
After an initial period of cooperation, the two growing nationalism among the large Serb
groups came into increasingly bitter conflict as minority in Croatia; and partly by the increasing
Tito's wider political ambitions became appar- Croat nationalism which this provoked.
ent. BH, because of its ethnic mixture, became a Croatia had much greater difficulty in
particularly important area of conflict. Muslims escaping from Yugoslavia than had Slovenia.
and Croats were faced with a choice between at The intervention of the Yugoslav army was
The IMF, the World Bank and economic policy in Bosnia

more forceful and less successfully resisted; and in March 1992. Muslims and Croats voted
the Serb minority within Croatia, with JNA sup- overwhelmingly for secession; but there was an
port, took control ofsubstantial areas of the country almost complete boycott of the vote by the Serbs.
where they were in the ascendant (for example, The tension between the two sides escalated,
the Krajina and Eastern Slavonia). A long and and the Yugoslav national army — virtually the
bitter struggle followed, and one-third of the only remaining institution holding the
country's territory remained under Serb control federation together — moved in, ostensibly to
when Croatia was internationally recognised in keep the peace. However, as Croats and
January 1992. In early 1997, the Zagreb authori- Slovenians had largely deserted, the JNA was by
ties have only just re-established control over now Serb-dominated; and the remaining
Eastern Slavonia, the last Serb-controlled area. Bosniacs (Bosnian Muslims and other supporters
With the withdrawal of Slovenia and Croatia of a united Bosnia) also left the army as it came
from the Federal institutions, Bosnia was faced into conflict with their compatriots. In May
with a choice between secession and remaining 1992, the army was notionally withdrawn from
within a Federation now heavily dominated by Bosnia; but in practice its Bosnian Serb compon-
Serb nationalists. The situation of the Bosnian ent remained, together with much of the
Serbs, however, was the mirror image of this — weaponry, to join with local Serb militias.
they faced a choice between being part of the Thus, while the war was largely brought
majority within a rump Yugoslavia, or being an about by external forces, it was primarily fought
ethnic minority within an independent Bosnia. between Bosnians. It was therefore extremely
The latter option was made more unattractive divisive, splitting Bosnian society into its three
by the rise in nationalism among the Croats and main ethnic components. For most of the war,
Muslims (itself largely a response to increasing the conflict was between the Serbs (whose main
Serb nationalism both in Serbia and within objective was secession and unification with
Bosnia), and by vigorously nationalistic Serbian Serbia) and an alliance of Bosniacs and Croats.
propaganda. However, in April 1993, the Bosniac/Croat
These dilemmas were made more acute by alliance broke down, as it became clear that any
Bosnia's ethnic composition, and the geograph- negotiated solution would take the form of a
ical spread of the various ethnic groups.3 While three-way division of territory, based at least
there was some degree of ethnic diversity partly on military control on the ground at the
throughout the whole of Yugoslavia, it was most time. There was also a large faction, at least on
marked in BH: uniquely, no single ethnic group the Croatian side, for whom the alliance was a
represented an overall majority of the popula- tactical one and the ultimate objective was
tion. I n 1991,44 per cent of the population were secession of the Croat statelet of Herceg-Bosna
Muslims, 31.5 per cent Serbs, and 17 per cent from Bosnia and its unification with Croatia.
Croats. Of the remainder, 2 per cent were of Full-scale war between Muslims and Croats
other ethnic groups, while 5.5 per cent followed in May of the same year.
considered themselves Yugoslavs (mostly The conflict between the Croats and the
people of ethnically mixed parentage). In all, 16 Bosniacs was brought to an end, following
per cent of children in BH were of mixed political intervention by the US, in February
parentage, a higher proportion than anywhere 1994. Nonetheless, this conflict seriously
else in the former Yugoslavia. embittered relations between Bosniacs and
There was a significant regional pattern in Croats, especially in mixed areas. The legacy,
the distribution of ethnic groups, with a which is most clearly illustrated by the current
disproportionate presence of Serbs in Western situation in Mostar, is a serious impediment to
Bosnia, and of Croats in Herzegovina. the establishment of new institutions and policy-
However, there was a very high level of integra- formulation in the Muslim/Croat Federation.
tion. Only three of 112 opstinas (the local Relations have been particularly badly
administrative areas) were essentially homogen- affected by the process of 'ethnic cleansing'.
eous in ethnic terms, while 30 had no overall Fear, intimidation, and violence (including
ethnic majority. Of the remainder, 37 had an massacres in some areas) have brought the
absolute majority of Muslims, 32 of Serbs, and country from a multi-ethnic mix developed over
13 of Croats. centuries to an almost complete polarisation of
The authorities responded to the political dilem- the population into distinctly Muslim, Croat,
ma by holding a referendum on independence and Serb areas. Some mixed areas (generally

8
Political and economic background

Muslim/Croat) remain; but, with the notable A.2 Political structures under
exception of Sarajevo, there is a high level of the Dayton Agreement
tension, and in some areas, such as Mostar,
ethnic cleansing and polarisation continue. Four years of war in Bosnia and Herzegovina
In addition to the death of some 250,000 were brought to an end by the Dayton
people, the war and ethnic cleansing gave rise to Agreement in December 1995. This established
enormous population movements, both Bosnia and Herzegovina (BH) as a single
internally and externally. It is estimated that sovereign country divided into two Entities: the
between lm and 1.4m people left the country as Serb-controlled Republika Srpska (RS), with 49
refugees, while a further million were displaced per cent of the territory and a population of
within the country. In total, this represents around 1.2m; and the Bosniac/Croat-controlled
about half of the country's pre-war population. Federation of Bosnia and Herzegovina, with 51
While the internal displacement largely repres- per cent of the territory and a population of
ented an exchange of members of one ethnic around 2.3m.4 The Federation in turn is divided
group for those of another, it gave rise to major into ten cantons, with boundaries essentially
increases in population in some areas (for fixed on ethnic lines: five are predominantly
example, the Muslim part of Mostar). This both Muslim, three predominantly Croat, and two
added to the strain on housing and infrastruc- ethnically mixed. There is no equivalent
ture resulting from war damage and dislocation, division of Republika Srpska (RS). The lowest
and compounded tensions between ethnic unit of government in each case is the
groups in these areas. municipality. (See Figure 1.)
While the Dayton Agreement envisaged a The ethnic division is strongly reflected in the
return of refugees and internally displaced distribution of power between the different levels
people to their areas of origin, this has yet to of government: in effect, power is concentrated as
happen on any significant scale, and it seems far as possible at the highest level consistent with
unlikely that the economic, social, and political ethnic uniformity. The central government has
conditions for large-scale return will be very limited power, its role being limited to the
achieved in the near future. bare minimum necessary for BH to be considered
As well as its dramatic effect on inter-ethnic as a single sovereign country (foreign policy,
relations, the war was also very destructive in international trade and debt, monetary policy,
physical terms (the economic damage arising immigration, international law enforcement, and
from the war is described in greater detail in air traffic control), plus relations between the
Box 1 in Section B1). Much of the damage was to Entities (inter-Entity transport, communications,
civilian targets, particularly to economic and and law enforcement).
social infrastructure, such as roads, railways, The Entities have responsibility across a
water and electricity supplies, schools, health much broader range of issues, including many
facilities and housing. However, the destruction which are more commonly held by national
was very localised: within areas which remained governments. These include:
under the control of the same ethnic group
throughout, the physical damage was relatively • defence;
limited, although such areas are still affected by • internal affairs, policing and justice;
the broader effects of the war; in other areas, • taxation and customs administration;
where the conflict was most acute and prolonged, • agriculture, industry, and other economic
the destruction is almost total. policies;
While the Serb area sustained less physical • health and social policies;
damage than the Muslim and Croat areas as a • environmental policies;
result of the conflict, it was seriously affected by • refugees and displaced persons; and
the more general economic disruption asso- • reconstruction programmes.
ciated with war, and especially by UN-imposed Under the Dayton Agreement, each Entity is
economic sanctions. These factors brought about also allowed to establish its own relationships with
a drastic downturn in economic activity and an neighbouring states, and to enter into agree-
almost complete lack of maintenance to ments with states and international organisations
infrastructure and productive facilities, which with the consent of the (national) Parliamentary
deteriorated seriously as a result. Assembly.

9
The IMF, the World Bank and economic policy in Bosnia

Within the Federation, the cantonal level of when elections were held on 14 September 1996,
government is responsible for education, at all levels except for municipalities within the
housing, public services, local land-use, and Federation, where elections were postponed
social transfer expenditures. However, these following allegations of fraud. The elections
responsibilities are automatically devolved to resulted in an overwhelming victory for all three
the municipal level in municipalities where the nationalist parties. While not surprising, this
majority ethnic group is different from that of seriously complicates the process of securing a
the canton as a whole. More generally, munici- constructive, collaborative approach to the
palities in the Federation have 'self-rule on local formation of institutions, both at the national level
matters'. In RS, the responsibilities of munici- and within the Federation. The postponed
palities correspond to those of the cantons and municipal elections are now expected in April.
the municipalities in the Federation. One important issue remains outstanding
Financially, the Entities retain control of under the Dayton Agreement, namely the status
customs and excise receipts within their of the Brcko corridor —a narrow strip of land in
respective territories, while in the Federation, northern Bosnia, which links the eastern and
cantons retain revenues from sales, income, and western parts of RS, and which is contested by
property taxes, together with revenues Serbs, Croats and Bosniacs. The corridor is
generated by charges for public services. The currently under Serb control, but is subject to
national government has no independent tax international arbitration. This was originally to
base, at least for the time being, but is wholly be completed by mid-December 1996, but the
dependent on transfers from the Federation deadline has now been extended (for the second
(two-thirds) and RS (one-third). Ultimately, it time) until February 1998. Whatever the find-
will be able to raise tax revenues, if this is ings, the announcement of the arbitration results
approved by the national parliament. could raise the political temperature substantially,
Under the Dayton Agreement, elections were due to the central strategic importance of the area,
to be held at all levels in both Entities within six to the mutually-exclusive claims of the various
nine months, and this deadline was met (just) parties, and the strength of feeling on all sides.

Figure 1 . The political structure

LEVEL:

National Bosnia and Herzegovina


(3-person collective presidency;
Council of Ministers;
bicameral parliament)

I
Entity Federation of Bosnia Republika Srpska
and Herzegovina (RS)
(President; government; (President; government;
bicameral parliament) bicameral parliament)

Canton 10 cantons

Local 73 municipalities 64 municipalities

10
Political and economic background

A.3 The pre-war economy Ireland or New Zealand, though less than in
other developed countries (UNDP, 1992, Table
After a brief experiment with central planning 34). While agriculture was an important source
after the Second World War, Yugoslavia of employment, representing about one-
positioned itself both politically and quarter of all jobs in the economy, the driving
economically between the communist East and forces of the economy were industry and (in
the capitalist West. This strategic position Croatia) tourism (Table 1).
enabled the country to receive substantial BH was poorer than Yugoslavia as a whole
financial support from Western donors through before the war, with GDP per capita 32 per cent
the 1950s and 1960s. In 1965-8, there was a less than the national average in 1989 (Vojnic,
temporary move towards market socialism, 1995, Table 4-2). Agriculture was substantially
before the principle of worker self-management more important, particularly in terms of
— a form of decentralised socialism — was employment: it employed around 40 per cent of
adopted. At the same time, there was a shift the work-force (about half part-time), and
towards commercial borrowing, leaving the accounted for about 14 per cent of output
country seriously exposed when the 1982 (EU/EBRD/World Bank, 1996b, pi03). The
Mexican crisis led to a generalised loss of economic importance of the industrial sector
confidence in lending to developing countries. appears to have been broadly in line with the
While Yugoslavia's debt situation was national average, while services were somewhat
substantially less serious than those of the major less significant, possibly reflecting the limited
Latin American debtors, the authorities development of tourism.
responded with a series of IMF- and World Major industrial sectors in BH included
Bank-supported adjustment programmes and energy (coal, coke and electricity); other raw
rescheduling of bilateral and commercial debts. materials (especially wood and bauxite); textiles;
This entailed a very rapid adjustment of the leather and footwear; and machinery and
balance of payments, and very large net electrical equipment. Much of the former
resource transfers to creditors, especially from Yugoslavia's armaments industry was also
the mid-1980s. This contributed to a serious relocated in BH, following Tito's split with
slow-down in growth from the very rapid rates Stalin, as it was seen as being safer in the most
prior to 1980, rising unemployment, and central of the Republics. Industrial production,
hyperinflation — and thereby, arguably to the both extractive and manufacturing, was domin-
conflicts of the 1980s. ated by about a dozen large socially-owned
The pre-1991 Yugoslav economy was conglomerates, which were mainly export-
relatively well developed and diversified, with a oriented, with about a thousand small and
strong industrial base and good infrastructure. medium enterprises, directed mostly towards
The workforce was skilled and well-educated, the domestic market.
with 9.7 per cent of 20-24-year-olds in full-time Electricity production was mostly thermal,
tertiary education — more than in the UK, using domestically produced coal, but with

Table 1 : Composition of production and employment in pre-1991 Yugoslavia


(percent)
GDP Employment
(1990) (1987)

Agriculture 10.9 25.8


Industry 44.8 26.8
Services 37.5 47.4

Notes: Employment data are from World Bank (1989); GDP data are from World Bank (1992a).
GDP figures exclude 6.7 per cent representing indirect taxes.

11
The IMF, the World Bank and economic policy in Bosnia

some hydroelectricity. Prior to the war, a small A.4 Recent economic


surplus was generated for export to Serbia and developments in the Former
Croatia. Coal production was 17.9m tonnes in
1990, but is subject to serious environmental Yugoslavia7
concerns: BH's brown coal and lignite have a
Apart from BH, where economic performance
high sulphur content; and desulphurisation has been greatly affected by the ending of the war
systems are not in place in power stations, and and the reconstruction programme, economic
would be expensive to instal. As well as coal and performance has been relatively consistent across
bauxite, BH has substantial reserves of iron ore, the various countries which formerly made up
lead, zinc, barytes, rock salt, and ceramic clays. Yugoslavia. Economic reform is proceeding, or at
In the services sector, BH had a major least beginning, though slowly and grudgingly in
capacity in civil engineering and construction, the Former Republic of Yugoslavia (FRY: Serbia
with 500 companies generating around 7 per and Montenegro); economic growth is relatively
cent of GDP, including a significant proportion modest, at around 2-3 per cent pa, with some
of export and overseas contracts. Tourism, expectation of a gradual improvement in the
however, remained relatively under-developed, next year or two in most cases; unemployment is
despite some efforts at promotion following the high and rising; and the balance of payments
1984 Winter Olympics. The services sector current account is generally in deficit, though to
accounted for the bulk of private enterprises. varying degrees, and with marked variation in
In 1990, about 1.6m ha (30 per cent of BH's ability to finance it. The greatest difference is in
total area) was farmed, 95 per cent of it by some inflation, which is well under control in Croatia
540,000 small private farms (generally less than and Montenegro, but a potential problem in
10 ha5); and the cultivated area was divided Slovenia, and very high in the FRY.
more or less equally between crops, pasture, and Bosnia and Herzegovina has performed very
meadow/fallow. BH's terrain is an important well, at least statistically. Economic growth in
constraint on agriculture, 45 per cent of the total 1996 was estimated at around 35 per cent,
area being forest, and much of the remainder reflecting a recovery of output from the
too steep for cultivation; and agriculture was artificially low level in 1995 because of the war,
technologically backward even before the war, coupled with the inflow of aid to finance recon-
during which much of the available machinery struction. However, output remains far below the
and equipment was destroyed. pre-war level, and unemployment is estimated at
Major crops were wheat and maize, while 50-60 per cent. Inflation has been kept very low,
livestock and forestry were very important, as reflecting the convertibility of the dinar at a fixed
was horticulture in the south of the country. exchange rate against the Deutschmark, coupled
Before the war, between one-third and half of with tightfiscaland monetary policies; and, while
total food requirements had to be imported; and there is a large current account deficit, diis is
cereal production was concentrated in what is entirely appropriate during the reconstruction
now RS, which had a substantial surplus in phase. Serious problems remain, as discussed
wheat production, while the Federation was elsewhere in this paper.
heavily dependent on imports. Slovenia remains the richest part of the
Forestry and wood products are important former Yugoslavia, with income per head of
sectors in both Entities, accounting for some 10 around $10,000 — more than Greece or
per cent of GSP,6 and $200m of exports before Portugal. It has been moderately successful
the war, and employing some 22,000 people in economically since breaking away from the
forestry alone. However, there are again former Yugoslavia. Economic growth was 3.5
important environmental constraints: deforest- per cent in 1995, and is expected to return to
ation 'could be seen in some areas of central this level in 1997 after dipping to about 2 per
Bosnia even before the end of the war' (EIU, cent in 1996 (though with stronger growth in
1996a, p20). investment). Inflation has returned to below 10
per cent, and the current account deficit is
relatively small. A successful bond issue
indicates renewed access to international finan-
cial markets; but this could yet be threatened by
the FRY's legal challenge to the country's
agreement with its commercial creditors.

12
Political and economic background

Around half of state industry has been despite marked reluctance on the part of the
privatised, but foreign investment has been Serbian leadership: there has already been some
limited, and rising real wages have driven out liberalisation of foreign investment laws, a
low-wage industries, leaving unemployment at privatisation law has been approved, and some
13 per cent (and rising). Slovenia's greatest trade reform is expected. Progress on reform
advantages relative to its former Yugoslav has been faster in Montenegro than in Serbia.
neighbours are its political stability, its relatively Economic growth was around 2.5 per cent in the
high level of development, its very limited first half of 1996 (down from 6.5 per cent in
involvement in the war, and its geographical 1995); but inflation remains around 30 per cent
position on the fringe of the EU. However, the pa, unemployment is high and rising, and there
benefits of Slovenia's growth to the other is a large ($2bn) trade deficit, financed from
countries in the region will be limited by its hard-currency resources held abroad. Both
preference for stronger economic links with the economic performance and the prospects for
EU rather than any development of stronger economic reform are likely to have been seriously
ties with its Balkan neighbours. affected by political instability following the
In Croatia, economic growth resumed at contested local elections in November.
around 4 per cent in 1996, despite heavy (and The Former Yugoslav Republic of
rapidly increasing) debts in the business sector, Macedonia (FYROM) has been promoted by the
widespread insolvencies, strongly deflationary World Bank as a case of successful structural
macroeconomic policies, and very high real adjustment,0 with significant progress on privat-
interest rates. Despite renewed growth, employ- isation and banking reform. However, this has
ment continues to fall, and the unemployment yet to be reflected in overall economic perform-
rate remains above 20 per cent. Inflation is still ance. Moderate economic growth was achieved
relatively low at 3.5^1 per cent, but there is a in 1996, after a decade of stagnation and
substantial current-account deficit. A three-year decline; and inflation is in single figures and
IMF programme is in preparation, and com- declining. However, exports fell by 30 per cent
mercial debts have been renegotiated. in the first half of 1996, increasing an already
The FRY (Serbia and Montenegro) has been large current-account deficit; access to foreign
pursuing conservative fiscal and monetary commercial lending has not been regained; and
policies, and is expected to negotiate a stand-by unemployment continues to rise. Inter-ethnic
arrangement with the IMF in 1997 (if the polarisation represents a potential threat to
remaining obstacles to IMF membership can be political stability and continued growth. The
lifted8), as a basis for debt renegotiation. regime for foreign direct investment is to be
Broader economic reforms are also possible, liberalised, and trade policy rationalised.

13
B. The IMF, the World Bank and economic policy

B.I The constraints on some donors) see the political tensions within
economic policy the Federation as being at least as problematic as
those between RS and the Federation.
The formulation of economic policy in BH is
complicated by three interlocking sets of Social and ethnic constraints
constraints: political/institutional, social and There are tensions at a number of levels; the
ethnic, and economic constraints. most obvious being between the three major
ethnic groups within BH. Such tension repre-
Political/institutional constraints sents a serious obstacle to any lasting political
These arise directly or indirectly from the terms settlement, and has a central role in the current
of the Dayton Agreement. Among the actual political inertia. These tensions also represent
terms of the Agreement, the most important is an important constraint to economic (or other)
the operation of the Central Bank as a currency interactions between the Entities, for example,
board for six years. This means, in effect, that the intimidation of people who cross between
domestic currency can only be issued against Entities (or their fear of violence), and the likely
foreign currency held by the government, which reluctance by some to buy goods from the other
effectively removes governmental discretion in Entity, if they were available. It is hoped that
monetary and exchange rate policy, and ethnic tensions can be eased by increasing
prevents budget deficits from being financed economic interaction between the Entities; but
domestically. (This is discussed further in the tensions themselves limit the pace at which
Section Dl.) this can be achieved. For economic and short-
A second key component is the administrative and long-term political reasons, it is therefore
arrangement of the country, specifically the essential to avoid compounding inequalities
very high (and arguably excessive) degree of between the ethnic groups, or creating new or
decentralisation of power, to the Entity level exacerbating existing sources of tension.
and, in the case of the Federation, beyond.
While the four levels of administration in the Another potential source of tension,
Federation may have been necessary politically, especially in the Federation, is between those
to secure the agreement, the arrangement will who stayed in Bosnia during the war and those
increase administrative costs substantially, and who left as refugees. Those who stayed,
may well prove cumbersome. especially in enclaves such as Sarajevo, Zenica,
The reliance of the political structures on and Tuzla, have in many cases been impover-
cooperation between ethnically-based political ished and traumatised by the experience. Many
leaderships gives rise to a considerable level of of those who left — who include most of those
political inertia, due to the mutual suspicion who were relatively well-off initially and many of
both between the two Entities and between the the most skilled and educated — have in varying
Muslims and Croats within the Federation (and degrees escaped these ill-effects; and many
within ethnically mixed cantons such as Mostar). professionals have accumulated substantial
This is exacerbated by the fact that Serb nation- savings while abroad. The resulting disparities
alists, whose ultimate goal is secession from BH in economic opportunities could give rise to
and unification with the FRY, have every considerable resentment as the refugees return,
incentive to ensure that their policies and in direct proportion to the opportunities
economic systems are incompatible with those available. This would be further compounded
adopted by the Federation, as a means of by programmes providing additional assistance
pushing BH towards partition. It should be specifically for returnees, to give refugees an
noted, however, that some observers (including incentive to return.

14
The IMF, the World Bank and economic policy

Overlaying these social constraints is the which coincided with it. The war damage is the
more general need to reduce poverty and access most obvious and severe constraint. BH's econom-
to basic necessities, such as food, health services, ic and social infrastructure and productive
housing, water supply, and sanitation. This is capacity has been severely reduced. (See Box 1.)
partly a moral issue, but also contributes to the In addition, the human capital base has been
political dynamics: increasing poverty was an severely eroded by the exodus of a large number
important factor contributing to the conflict in of educated and skilled people. Of those who
the Former Yugoslavia; and the persistence of remain, people with specialist skills have been
chronic poverty would be a substantial obstacle internally displaced, and it is likely that many
to a durable political solution in BH. Reducing will no longer be in (or able to return to) an area
poverty would require the creation of employ- where their skills can be used productively.
ment opportunities, not only for the 50-60 per The Former Yugoslavia's strategic position
cent of the workforce who are currently between East and West was lost with the end of
unemployed, but also potentially for more than the Cold War, and with it the prospect of favour-
a million refugees if and when they return. able financial and economic support from both
sides. Reconstruction assistance has been a
Economic constraints temporary substitute, but will be of limited
Economic constraints arise not only from the duration (until about 1999). A viable economic
effects of the war, but also from a number of future is unlikely to be based on continued
other changes in the economic environment funding at the pre-war level.

Box 1: Economic and social effects of the war


Population: Some 250,000 people were killed in the war. A further 1—1.4 million left the
country as refugees, of whom only 6 per cent have returned; around a further million were
internally displaced, of whom 360,000 remain homeless; and some 2-300,000 entered the
country as refugees from neighbouring states. More than 200,000 people were wounded, of
whom 13,000 have permanent physical injuries, including 5,000 who have lost limbs. About
245,000 people have been or are being demobilised in the Federation and 180,000 in RS.
This implies that around two-thirds of the pre-war population of 4.4 million have been killed,
disabled, internally or externally displaced or demobilised. An estimated one-third of the
population (about 1.2million people) are suffering from post-traumatic stress disorder.

Landmines and other hazards: There estimated to be between 1.5 million and 4 million land-
mines in BH, of which only about 15,000 had been located as of November 1996. These are
mostly concentrated in bands about 5km wide along former lines of confrontation, including
areas around Sarajevo, Banja Luka, Zenica, Vitez, Mostar, Srebrenica, Tuzla, Medugorje,
Bihac, Zepa, Gornji Vakuf, and Gorazde. In addition, there is other unexploded ordnance in
areas of conflict, and booby traps remain in areas of ethnic cleansing. Coupled with uncer-
tainty about the location of mines, this is a serious deterrent to land use. Mines have also been
laid in some areas to obstruct the use and reconstruction of infrastructure.

Transport and communications: More than 2,000km of main roads are in need of immediate
repair, all railway lines have been rendered inoperable, and Sarajevo airport was partly
destroyed and closed to civilian traffic. All bridges connecting BH with Croatia were
destroyed, and a total of 70 bridges have yet to be rebuilt. Public transport vehicles and facili-
ties were destroyed or damaged, or have become run down due to lack of maintenance.
Around 50 per cent of the telecommunications network has been damaged or destroyed,
including transmission and switching equipment, buildings, towers, overhead cables and the
entire backbone transmission network. Call-completion rates in the worst affected areas are
1-2 per cent at peak times, compared with 35-38 per cent before the war.

15
The IMF, the World Bank and economic policy in Bosnia

Box 1: Economic and social effects of the war (continued)

Energy and heating: Almost all power stations, thermal and hydro, were damaged either
directly or by lack of maintenance during the war, and more than 50 per cent of electricity
generation capacity was put out of operation. At the end of 1995, electricity generation was
estimated to be operating at only 10 per cent of capacity. In addition, 60 per cent of the trans-
mission network and control system was seriously damaged and about 50 per cent of the dis-
tribution network damaged or destroyed. District heating systems were either seriously dam-
aged (as in Sarajevo, where the number of households served fell by about two-thirds) or dis-
rupted by lack of energy supplies (as in Banja Luka, where only 5-6 per cent of installed
capacity was in use in 1995-6). Further damage has occurred due to non-use and lack of
maintenance.

Water and waste management: War damage and lack of maintenance, compounded by popu-
lation movements, imposed serious strains on the water and sanitation systems. Leakage-loss
rates for water increased from 30 per cent to 50 per cent, and 27 of 69 municipalities in the
Federation no longer have 24-hour supplies. Clogged sewage and drainage systems have
caused extensive flooding. While war damage has been relatively limited in RS, facilities have
suffered from lack of maintenance. Cross-boundary access to water supplies has been denied,
further limiting access. Solid waste services have been affected by extensive damage to equip-
ment; and limited access to landfill sites due to landmines has led to over-use of small urban
sites.

Housing: In the Federation, 50 per cent of the housing stock was damaged, and 6 per cent
destroyed; in RS, 24 per cent was damaged and 5 per cent destroyed. Deterioration of the
remainder has occurred due to lack of maintenance. About 90 per cent of destroyed and
damaged housing has yet to be repaired, and some 30 per cent of inhabited housing has no
glass in the windows.

Industry: As well as physical destruction, industry and finance have been affected by the dis-
ruption of domestic and external trade links, and by the legal confusion created by the con-
flict. The industrial sector is operating at about 15-20 per cent of its capacity in the Bosniac
area of the Federation, and at 8-10 per cent in RS. Industrial activity has also been reduced,
though to a much lesser extent, in Croat areas. Non-agricultural unemployment is estimated
at 50 per cent in the Federation and 60 per cent in RS.

Finance: The freezing of foreign exchange deposits at the beginning of the war created a
deep distrust of the banking sector, compounding its already weak financial position. Banks
have large foreign exchange liabilities, while household deposits are negligible, and commer-
cial and public sector deposits very low; 90 per cent of bank assets are non-performing. The
capital of the large state-owned banks has been wiped out, while the newer private banks are
small, under-capitalised and inexperienced. As a result, only limited amounts of short-term
credit are available, and only at very high real interest rates.

Agriculture: 70 per cent of farm equipment and 60 per cent of livestock were lost during the
war, and farm buildings and irrigation equipment damaged or destroyed. Some 15 per cent
of farm land and 20 per cent of forests remain inaccessible due to landmines, and high-value
orchards and vineyards were destroyed. In 1995, wheat, maize and potato crops were 30-40
per cent below pre-war levels, and fruit production was down by about 50 per cent. Forestry
and food-marketing systems were also disrupted.

Health: More than 13,000 people sustained permanent physical injuries during the war, and
communicable diseases increased by between 100 per cent and 400 per cent. Between 35 per

16
The IMF, the World Bank and economic policy

Box 1: Economic and social effects of the war (continued)


cent and 50 per cent of the health infrastructure was destroyed, and 35 per cent of hospital
bed-capacity was lost. There has been a 50 per cent reduction in the number of active health
personnel, and there are serious shortages of essential drugs and other supplies. Infant mor-
tality rates and premature deaths have increased dramatically, doubling in some areas.

Education: Around 70 per cent of schools were damaged, destroyed or requisitioned for mili-
tary use or as centres for displaced people. In addition, budgetary resources for salaries and
other recurrent expenditure dried up in many areas; many teachers departed, to be replaced
by unqualified volunteers; materials such as textbooks and basic furniture remain scarce; and
many schools are without water and/or electricity supplies. Bosniac areas were worst affected,
while education was sustained in Croat areas by financial support from Croatia. In RS, there
was significant physical damage, but the main problem was lack of recurrent expenditure due
to the UN embargo and hyperinflation. Many students left full-time education prematurely,
or suffered a hiatus, during the war. The quality of education was seriously affected, and both
the school year and the school day were shortened to accommodate a shift system.

Sources: This Box is based mainly on EV'/EBRD/World Bank (1996, passim), with supplementary information from World Bank
(1996b) on population, Muratovic (1997) on population and housing, World Bank (1995c) on landmines, and EBRD (1996) on
electricity and telecommunications.

The economic system of the Former Globalisation and the transition process else-
Yugoslavia was proving unviable long before where in Eastern Europe represent additional
the war. Even without the war, some form of challenges. In particular, BH's exports must
economic transition would have been necessary. compete with those of a number of other
Yugoslavia's debt burden was also heavy prior developing country and Eastern European
to the war. In the light of the war-damage to the economies with (in some respects) similar
economy, BH's share of the debt is clearly unsus- economic endowments, as all scramble to attract
tainable. While die World Bank has already acted foreign investment and increase their foreign
to provide some debt relief, and action is exchange earnings. A viable economic future
expected from bilateral and commercial bank will depend on the country's ability to compete
creditors, some potentially serious problems effectively in the world market.
remain. (See Section B2.) Finally, the current level of aid should also be
In addition to the foreign debt, the govern- regarded as a constraint. Clearly, it would be
ment faces a heavy burden of domestic liabil- possible to provide additional aid; but, given the
ities, particularly foreign exchange deposits tight financial constraints on most donors' aid
frozen during the war; and arrears owed to programmes, this would have to be at the
pensioners, soldiers, and public servants. These expense of current (or increased) allocations to
liabilities are very considerable (in the order of other, mostly poorer, countries. The current
DM13bn); and failure to settle them in a satis- level of aid to Bosnia is already very high
factory manner could be politically destabilis- compared with many other post-conflict
ing. Some 80 per cent of all households had countries in the recent past, although it is both
foreign exchange deposits of up to DM 1,000 richer and better-endowed with economic
frozen; and public sector workers (including resources. Aid commitments to Bosnia for 1996
soldiers) are owed substantial salary arrears. (GNP per capita $250-500) amounted to
Settling arrears to pensioners should be around $400 per capita, compared with $80-90
regarded as a high social priority, in view of the for Rwanda (GNP per capita $80) and $60-70
very high incidence of poverty among elderly for Mozambique (GNP per capita $60) at an
people. equivalent stage of reconstruction.

17
The IMF, the World Bank and economic policy in Bosnia

B.2 The debt dimension independent states. In other words, by accepting


this principle, the RS authorities appear to be
Yugoslavia faced a significant debt problem prior accepting a greater financial burden in order to
to the war, and efforts at external adjustment to be treated as if they were seceding from BH,
service the debts represented an important thereby removing a potential obstacle to their
contributory cause of the conflict. Now, BH has doing so.
inherited its share of the foreign debts of the The normal sequence of debt reduction is for
former Yugoslavia; and its debt situation is a the bilateral debt to be renegotiated first,
great deal more serious than that of Yugoslavia in followed by the commercial bank debt, and only
the 1980s. Bosnia's debt situation is more than then (if at all) the multilateral debt. In Bosnia's
usually complicated. It is not simply a question of case, this might well be reversed. The only
having too much debt and needing tofindways of concrete progress made to date has been with the
reducing it to a sustainable level; in Bosnia, there World Bank, which has consolidated BH's
are two additional dimensions to the problem. $625m debt over 30 years at 0.5 per cent interest.
First, the debts accumulated by the Former This was done by treating Bosnia as a new
Yugoslavia had to be allocated between the member of the Bank (rather than as a successor
independent states into which it is now divided. to the Former Yugoslavia), and was presumably
Second, the cost of servicing the Bosnian share of preferred to the option of including Bosnia
the debt has to be divided between the two in the recent multilateral debt initiative for
Entities: while the central government is formally highly-indebted poor countries (the 'HIPC
responsible for servicing the debt, it is ultimately Initiative') as providing more immediate
dependent on contributions from the Entities to benefits."
do so. Bilateral debt cannot be reduced, or even
The first issue has, in principle, been rescheduled, until an IMF programme is in
resolved. Of the Former Yugoslavia's $15.3bn of place. This makes the timing very uncertain — it
external debt at the end of 1991, $ 12.2bn could is hoped, but by no means assured (see below),
be divided between the Republics according to that a Fund programme will be in place by June.
the 'final beneficiary' principle.10 The remaining However, there is a much greater need for
$3.1bn was divided up in proportion to the five urgency in the case of the commercial bank
independent countries' shares of the Former debt, which must reach the 'agreement-in-
Yugoslavia's IMF quota. This resulted in BH principle' stage12 before 30 June 1997. The
taking responsibility for a total of $ 1.9bn of 1991 reason for this is that the previous rescheduling
debt, which, with accumulated arrears and of the Former Yugoslavia's debt (the New
charges, has increased to $3.4bn. There is, Financial Agreement, or NFA, of 1988) included
however, a potential complication with respect a joint and several liability' clause between the
to the part of this debt owed to the commercial Republics. This means that each individual
banks, as discussed later. Republic could be held liable for the entire
The second issue — the division of the amount of the Former Yugoslavia's debts in the
Bosnian debt between the Entities — was event of non-payment by the other Republics.
originally to be resolved in line with the two- The banks agreed to waive this part of the
thirds/one-third rule used in other contexts. agreement in June 1996; but the extension of
However, the entities have now agreed to use the waiver beyond 30 June 1997 is conditional
the final beneficiary principle instead. The on an agreement-in-principle on BH's bank
switch to the final beneficiary principle has two debts before that date.
major implications. On a financial level, it is In principle, it would be possible for the
likely that the RS will end up paying significantly banks to extend the deadline. However, this
more, and the Federation significantly less, than would require the support of banks holding
under the two-thirds/one-third rule. At first two-thirds of BH's debt; and the FRY has
sight, this might appear to suggest the possibility bought enough of Bosnia's commercial bank
of the RS side reneging on the agreement. debt on the secondary market to be able to block
However, there is also a significant political such a move. It is therefore imperative to reach
dimension. The final beneficiary principle is the agreement-in-principle before the end of June,
approach normally used to divide up the debts even if this is before the Paris Club agreement.
of a country (such as the Former Yugoslavia) There is concern in some quarters that the terms
which splits into two or more separate achieved on commercial bank debt may be less

18
The IMF, the World Bank and economic policy

favourable (to BH) if it is agreed before the Paris FRY debts. After a re-division, the FRY
Club; but this may be a price which has to be paid. authorities would then be in a position to
If agreement-in-principle is not reached in cancel a substantial part of their own debt.
time, BH's debt would be re-merged with the
• It is also possible that there is a political
FRY's; and the FRY could block any reversal of
motivation. By re-merging their commercial
this move, unless (ironically) their legal action
against the Slovenian debt deal were successful. debts with those of BH, the FRY authorities
Any debt agreement would then need to be might be trying to restore an obstacle — albeit
negotiated jointly by the FRY and BH authorities a largely symbolic one — to BH's autonomy. If
(and the Macedonians if they were in a similar the debts held by the FRY are those attribut-
position), and provide equivalent treatment to able to RS under the final beneficiary
both (or all) parties. This would seriously principle, the authorities could off-set any
complicate the negotiation process, delaying a negative effect on RS by cancelling their debts.
final settlement, possibly for some years; and, This would allow the RS authorities to benefit
given the much more limited goodwill towards financially as well as politically from their
the FRY, it would almost certainly provide less acceptance of thefinalbeneficiary principle for
favourable terms. The prolonged hiatus would the inter-Entity allocation of debts.
also limit BH's access to international financial Some of these motivations, at least, could give
markets until there was a resolution of the issue. the RS authorities themselves an incentive to block
Even if agreement-in-principle is reached, it any extension of the joint and several liability
would seem possible, at least, that the FRY could waiver. In the third case, there would be a direct
block the finalisation of the deal, which gener- financial benefit to RS, in the form of a greater
ally requires a greater than two-thirds majority degree of debt reduction than would otherwise be
of participating creditors. However, the relaxed available, as well as the political advantages. In the
attitude of the authorities to this issue suggests first two cases, the benefits would accrue mainly to
that they expect a loophole to be available. Even FRY; but the RS might wish to support this, either
if it were not, BH's debt would remain legally for reasons of Serb solidarity or in return for a quid
distinct from that of the FRY; and the blockage pro quo of some kind. In view of the likely financial
of afinaldeal would seriously reduce its value on costs (in the form of less favourable treatment of
the secondary market. This could allow the BH debt), a quid pro quo would be essential under
authorities to buy back their debt informally on thefirstcase.
the secondary market and, in effect, to cancel it.13 The question of the complicity or otherwise of
There are various possible motivations for the RS authorities is critical, because this could
the FRY authorities' actions in buying Bosnian encourage them to obstruct the achievement of
debt and seeking to block a deal:14 agreement-in-principle before the end of June.
The most obvious way of doing this would be to
• They may be hoping that the FRY could
delay the approval of an IMF programme. The
obtain a more favourable deal on its own
absence of an IMF programme would not
commercial debt if it were treated jointly with
represent an insuperable obstacle to agreement-
that of BH. In these circumstances, there
in-principle, as the procedures for commercial
might well be some pressure on banks from
bank renegotiation are somewhat more flexible
their governments to provide debt reduction,
than those of the Paris Club. Nonetheless, there
so as not to jeopardise BH's economic
would be substantially greater impetus towards
recovery; and this would allow the FRY to
reduction of commercial bank debt with an IMF
benefit from equivalent terms. Such pressure
programme and the prospect of a Paris Club
for favourable treatment would be unlikely if
agreement than without. If an IMF programme
the FRY debt were treated separately.
were delayed, this could lead to a more general
• The FRY authorities may hope to reduce disruption of BH's financial arrangements, for
their own debts more directly. While any example by delaying World Bank adjustment
subsequent re-division of the debts would lending, and would effect negotiations with the
again be based on the final beneficiary commercial banks.
principle (so that the FRY-held debts would As noted above, the $825m owed to bilateral
still be owed by BH), it might be possible for creditors can only be reduced once an IMF
the FRY to exchange the debts it holds with programme is in place. The authorities are
other creditors, possibly at a discount, for hoping to secure a reduction of 80 per cent in

19
The IMF, the World Bank and economic policy in Bosnia

net present value (NPV) terms;15 but it seems was terminated). It is now represented on the
possible, at least, that they will be offered only 67 Executive Boards of both institutions by the
per cent. This might be topped up to 80 per cent Executive Director for the Netherlands.
after a track-record of economic adjustment The most important obstacle to IMF and
policies has been established (in line with the World Bank membership was the need to settle
HIPC Initiative). Much will depend on the BH's share of the arrears accumulated by the
strength of the political pressures for more former Yugoslavia. This was a relatively minor
favourable treatment. problem in the case of the Fund, as the arrears
A 67 per cent reduction in the NPV of were fairly small (less than $50m). They were
commercial and bilateral debt, coupled with the settled by a bridging loan from bilateral donors,
consolidation of World Bank debt would reduce enabling BH to join the Fund and make a first
the overall NPV of debt to about $1.5bn, or 250 credit tranche drawing of 25 per cent of quota,
per cent of estimated 1996 exports. The absolute without policy conditionality. This was then
NPV figure would be increased over time by new used to repay the bridging loan.
borrowing, although this should be relatively The problem was much greater on the World
limited, and mostly on concessional terms. The Bank side, as arrears to the Bank amounted to
ratio of NPV to exports should decline rapidly if some $450m. However, this problem was
the predicted rapid growth of exports is resolvedflexiblyand constructively by the Bank,
achieved: based on the World Bank's projections which consolidated the entire amount of
(World Bank, 1996b, Table 5.2), the NPV of BH's Bosnia's $625m debt to the Bank over 30 years,
external debt might reach about $2bn — around at 0.5 per cent annual interest. This could be
80 per cent of exports16 — in 2000. done only by treating BH as a new member of
However, the export projections appear very the Bank, rather than as a successor state to the
optimistic (quite apart from the political risks), former Yugoslavia, following the precedent
so that the rate of improvement may be established by Bangladesh in 1975.
substantially slower. The effect of slower export Relations between the IMF and the World
growth is threefold: as well as reducing the level Bank and the authorities were complicated
of exports, and thus increasing the NPV/export initially by the Muslim domination of the
ratio directly, the need for additional borrowing national government prior to the September
to finance the larger current-account deficit 1995 elections, and the resulting suspicion of
increases the level of the debt, and the higher the RS and Croat political leaderships. Since the
level of debt increases interest payments, adding elections, problems have included the split of
to the need for additional borrowing. responsibilities between the Federation and the
If export growth were reduced by one-third, RS, and the strong mutual suspicion between
without a corresponding reduction in imports, the two; and the tensions between the Croat and
and the resulting financing gap were filled with Muslim sides within the Federation, resulting in
non-concessional borrowing, the NPV/export the continued de facto operation of the Croatian
ratio would remain at about 250 per cent in 2000. statelet of Herceg-Bosna. These factors contrib-
This outcome could be avoided by reducing the uted to a prolonged hiatus in the formation of
growth rate of imports; but to neutralise die the national government, and a continuing state
impact would imply imports some 20-25 per cent of political inertia.
below the levels currently projected in 2000; and, Nonetheless, the IMF and the World Bank
without the possibility of devaluation (see Section maintained contacts with at least some of the
D1), this would imply a similar reduction in GDP. authorities during this period. The IMF, in
This would have a serious impact on incomes and particular, was among the first to establish links
employment. with the RS authorities, at the beginning of their
relations with BH immediately after the Dayton
Agreement. The Bank was initially in contact
B.3 IMF and World Bank only with the Federation side, but has, since the
relations with the authorities elections, established a more symmetrical
relationship. Both the Fund and the Bank are
BH joined the IMF in December 1995, and the now in regular contact with the authorities of
World Bank in April 1996 (although its both Entities as well as the national government.
membership was back-dated to February 1993, The World Bank started to support
when the membership of the former Yugoslavia reconstruction in BH before the country actually

20
The IMF, the World Bank and economic policy

joined the Bank, through a Trust Fund managed expected to make the transition from concession-
by the Bank, funded by donor contributions. al IDA credits to non-concessional IBRD loans in
This also allowed part of the Bank financing to be 1998, reflecting its increasing per capita income
provided on grant terms. Thefirstproject was the and improving creditworthiness.
Emergency Reconstruction Project in February An IMF programme is also expected in the
1996. A further twelve projects have been near future. While BH is eligible for concession-
approved since, for a total of $325.6m of IDA al funding under the enhanced structural
funds ($ 1,045.5m including cofinancing by other adjustment facility (ESAF), the first programme
donors). (See Table 2.) Only five of the 13 loans will be a twelve-month stand-by arrangement
have included RS: the remainder, accounting for (SBA), on non-concessional terms. The SBA
80 per cent of total funding and 83 per cent of option is preferred because it takes less time to
World Bank resources, have gone exclusively to prepare than an ESAF, which would entail
the Federation. longer and more detailed policy discussions.
Further support is expected to take the form of The important consideration at this stage is to
three approximately annual policy-based get an IMF programme in place, to allow debt
structural adjustment credits (SACs). BH is negotiations to proceed (see Section B2), rather

Table 2: World Bank Programmes in Bosnia and Herzegovina

Date Coverage Amount (USSm)


Effective World Bank Total

Emergency Recovery 3/96 F 45.0 160.0


Emergency Farm Reconstruction 4/96 F 20.0 50.4
Water, Sanitation and Solid
Waste Urgent Works 5/96 F 20.0 70.0
Emergency Transport Reconstruction 6/96 F 35.0 163.0
War Victims Rehabilitation 6/96 F 10.0 30.0
Emergency Education Reconstruction 6/96 F/RS 10.0 32.8
Emergency District Heating
Reconstruction 7/96 F/RS 20.0 40.5
Emergency Landmine Clearance 8/96 F/RS 7.5 67.0
Emergency Housing Reconstruction 8/96 F 15.0 60.4
Emergency Demobilisation and
Reintegration 8/96 F/RS 7.5 20.0
Emergency Public Works and
Employment 8/96 F/RS 10.0 45.0
Emergency Electric Power
Reconstruction 9/96 F 35.6 196.4
Transition Assistance Credit 9/96 F 90.0 110.0

Total F 270.6 840.2


F/RS 55.0 205.3
all 325.6 1,045.5
Notes: Data are from World Bank (1996c), and cover loans effective in November 1996.
Coverage: F = Federation only; F/RS = Federation and Republika Srpska.

21
The IMF, the World Bank and economic policy in Bosnia

than the nature of the support provided. reform process is either essential to the establish-
However, the high cost of the funds provided ment of BH as a state or mandated by the Dayton
suggests either that they should not be drawn (a Agreement (for example, the formation of the
'classical stand-by'), or that they should be added Central Bank, customs authorities, and so on).
to the reserves, rather than being used to finance Nonetheless, some elements of the policies
imports. The intention is to negotiate an ESAF, being thus enforced are less clear-cut; and no
which would cover a further three years, while distinction is made between the essential state-
the SBA is in place. forming components of the policy proposals
The policy conditionality included in an SBA and those relating to the particular economic
would effectively be limited in BH's case. The strategy to be adopted. Thus, while the
conditions relate only to macroeconomic variables establishment of a regulatory framework for
such as the budget deficit, the money supply, and international trade is necessary, the abolition of
the exchange rate; and these are in any case administrative controls and the setting of tariffs
effectively imposed by the currency board at a low and uniform rate, with minimal exemp-
arrangement mandated under Dayton. An ESAF tions, is not. Other measures, such as privatisa-
would go beyond this into structural policies. tion, are wholly unrelated to the Dayton terms.
While this would require more extensive policy However, the authorities appear to accept the
discussions, with greater scope for dispute with principles of reform which have been put
and between the Entities, the policies entailed forward, most of which are probably either
would overlap significantly with the World Bank sensible, or inevitable in the current circum-
SACs. stances (subject to the concerns discussed in
The extent of pro-active policy-making by the Section D). It is difficult to assess the balance
authorities appears to be limited. The process is between genuine commitment and compliance
one not so much of negotiation as of consulta- based on financial dependence, but there is at
tion: the IFIs consult the various authorities, least an element of the former. RS (1996) would
formulate policy proposals, and put them to the appear to suggest that the financial aspect may
authorities, who accept them. Moreover, the be of greater importance, and genuine commit-
donors (and other international agencies, such ment more limited, in RS.
as UNOHR) appear to be presenting a very The unanimity of the donors is presumably
united front: all are firmly committed to the based on the fact that much of the package being
general principle of economic reform, and seem proposed is essential, and that it will not be
agreed on virtually all the details. The result is implemented unless they speak with a single
very heavy conditionality: the authorities are voice, and make it impossible for any of the
reminded that if they do not comply with the authorities to dilute or obstruct it. The elements
programme outlined, there will not be another which go beyond the essential are at least accept-
donor conference — or, by implication, further able enough to the rest of the international
substantial assistance for reconstruction. community to be seen as a price worth paying
It is clear that the threat is not limited to a for securing the essentials — although there is
major failure of the reform. The OHR/EU/UST little evidence of dissent.
(1997) paper, 'elucidated with the cooperation Three more specific concerns may be noted
of the IM F and the World Bank, states explicitly with respect to the international community's
that: approach to promoting the reform process:
There is no roomfor hesitancy or halfmeasures and the • The underlying ideology does occasionally
reform program must be implemented quickly and in show through. The OHR/EU/UST (1997)
full...[I]f it were limited in urgency or scope...the paper, for example, concludes that: 'die time
willingness of the international community to provide has come to shift the emphasis of economic
large-scale resources would...be likely to diminish. policy-makers [NB not for policy-makers
themselves to shift their emphasis] from
As a general principle, such heavy-handed reconstruction after the ravages of war to policy
conditionality seems less than ideal. However, it reform after the ravages of socialism.'
would probably be necessary to ensure the imple-
mentation of any kind of policy framework — not • EU/EBRD/World Bank (1996a, plOl)
because of political opposition, but because of the proposes using the media to promote the
inertia generated by the current political principles of policy reform and transition,
arrangements. Much of the initial part of the through soap operas as well as educational

22
The IMF, the World Bank and economic policy

programmes, documentaries, and debates. to be a great deal of optimism on this score, the
This seems highly questionable, particularly in prospect of achieving it remains uncertain, and
the light of the role of the media in the conflict, at best distant. There is also a conspicuous
and would seem to be at odds with the objec- divergence of views, both between the EU itself
tive of increasing its political independence. and other donors, and between the Federation
As well as the stick of reducing reconstruction and national authorities on the one hand and
assistance and withholding debt reduction, a the RS authorities on the other (Box 2). This
carrot has been dangled before the audiorities tactic would therefore seem to carry with it a
in the form of accession to the European high risk of disillusionment and frustration in
Union. While this is seemingly an almost the medium term; and could create a rift
universally-held objective, and there appears between the two Entities.

23
The IMF, the World Bank and economic policy in Bosnia

Box 2: Divergent views on BH accession to the European Union


There is a marked disparity in the views of different parties on the likelihood and desirability of
BH's accession to the European Union in the foreseeable future. This can be seen from the
following quotes.
The donor vision of the benefits:
Donors, in putting forward their policy recommendations, have put substantial emphasis on the
potential benefits of EU accession and the necessity of market-oriented economic reforms as a
prerequisite for its achievement:
Joining the European Union and becoming increasingly integrated with the rest of Europe is the common
vision shared by the people of Bosnia. It is a vision ofprosperity for every citizen of Bosnia, and a vision of a
modern market economy, and underpinned by a small but effective government ....To realise this vision of
integrating with Europe would require forward-looking policies and reform.
(EU/World Bank, !99f>b, pi)

The National Government view:


The national government appears to aspire to EU accession.
The Government of Bosnia and Herzegovina will continue its negotiation with the EU in relation to
gaining access to the PHARE programme and to conclude a Trade and Cooperation Agreement, and
Financial Protocol. The Government of Bosnia, and Herzegovina reiterates its position that Bosnia and
Herzegovina deserves special treatment, as an unprecedented case, for Associate Membership in the European
niOn
- (World Bank, 1996d, plO3)

However, there are two dissenting voices:

The broader EU view:


Despite its involvement in the preparation of the first document quoted, elsewhere the EU has
been much more ambivalent:
In the case of Bosnia-Herzegovina, the peace process, reconciliation between the various sides in the civil
war and reconstruction mustfirst be seen to bearfruit before further steps, such as the negotiation of a Europe
Agreement, can be taken. Only when they have borne fruit could the Pliare programme be used as a means of
preparing Bosnia-Herzegovina ...for accession to tfieEU.
1 s J
' ° (European Parliament, plO)

This suggests that the European Parliament, at least, may be less enthusiastic about the prospect
of BH membership than the Commission. Some other donor documents co-authored by the
Commission itself have also been noticeably reticent on the possibility of BH accession:
OHR/EU/UST (1997, p6), for example, says only that the EU is 'prepared to consider
establishing a contractual relationship' with BH.

The RS view:
While the second quote above is probably a realistic representation of the aspirations of
Federation representatives on the national government, it is by no means clear that their
enthusiasm is shared by the RS. The RS Policy Statement on 'Foreign Economic Relations Policy'
(RS, 1996, ppl 19-120), for example, does not mention the EU, referring instead to a free-trade
zone within the former Yugoslavia and 'projects for integration within the Balkans'.

24
C. Donor-related issues

Cl. Disbursement delays major factor in the development ofa more coopera-
tive approach on the part of the RS authorities.
As is almost invariably the case in reconstruction There are, inevitably, marked differences
(or other aid) programmes, there has been a between donors in the translation of pledges
substantial difference between pledges and into actual disbursements. (See Table 4). While
actual disbursements and project implementa- this no doubt partly reflects differences in the
tion: as of November 1996, of $ 1,851m nature of their support and its distribution
committed, only $720m had been disbursed. A between sectors, it seems likely that some more
further $456m was under implementation, of general variations, for example, in political
which contracts had been signed for $330m commitment or bureaucratic efficiency, also
(EU/World Bank, 1996a, Table 3). However, play a role.
this is no worse than is normal in such Overall, multilateral agencies have performed
circumstances. A substantial part of the $ 1,851 m somewhat better than bilateral donors in trans-
commitments — including all of the World lating pledges into commitments and projects
Bank programmes — was designed to be phased under implementation; but a significantly larger
over a period beyond the end of 1996. proportion of pledges have been disbursed by
Moreover, where delays have occurred, this has bilaterals, partly due to the apparent failure of the
EBRD to get any projects to the implementation
often been as a result of political conditionality. stage. The EU has also performed relatively
(See Section C2.) weakly in terms of disbursements, while the
Disbursement delays may have hampered the World Bank has been well above average in both
reconstruction process to some extent, which in implementation and disbursement.
turn suggests some negative effect on employ- Among bilaterals, the G7 have mostly
ment. However, their wider economic effects performed reasonably well, with the exceptions
are likely to have been limited, particularly as ofJapan and Italy. Smaller developed countries
balance-of-payments support has not been have been more variable, the Netherlands per-
greatly affected. The delays to the reconstruc- forming well (possibly reflecting their status as
tion process may have some significance, Bosnia's representative within the IMF and
however, if they mean that other components of World Bank), while Spain has performed partic-
the transition process, such as privatisation, take ularly badly. The weakest performances are
place at a lower level of infrastructure and registered by countries which might be
economic activity than was anticipated. (The expected to be particularly partisan — ie the
pace of privatisation is discussed in Section D3.) FRY, Russia and the Islamic countries (Saudi
Disbursement delays, and particularly those Arabia, Kuwait, Turkey and Malaysia)" —
related to political conditionality, have altered possibly reflecting lack of experience in aid or
the balance of assistance between the Federation limitations in their administrative capacity.
and RS, as the latter has been much more Between them, these six countries made pledges
affected. (See Section C3.) However, this does of $183.5m (nearly 10 per cent of the total), but
not so far appear to have done any serious had disbursed only $5m (2.7 per cent) of this by
damage to the political situation; and the need October 1996, compared with an average of
for international financial support has been a 48.4 per cent for other bilateral donors.

25
The IMF, the World Bank and economic policy in Bosnia

Table 3: Pledges, commitments, project implementation and disbursements


by donors, October 1996

Donor Pledges a:> per cent of pledges


($m) commitments implementation disbursements

EU 367.1 105 58 28
World Bank 330.0 99 89 49
EBRD 80.2 109 0 0
Islamic Dev. Bank 15.0 127 40 40
other multilateral 25.0 95 55 51
TOTAL MULTILATERAL 817.3 103 64 35

USA 281.7 105 82 44


Japan 136.7 70 32 27
Netherlands 100.0 100 70 58
Italy 63.7 111 12 12
Russia 50.0 0 0 0
Saudi Arabia 50.0 84 40 10
Norway 40.8 104 92 92
UK 39.7 98 98 86
Germany 39.3 99 91 72
Kuwait 35.0 100 0 0
Switzerland 33.5 82 78 36
Sweden 30.4 103 65 61
Turkey 26.5 43 8 0
Canada 25.4 88 46 46
Spain 17.5 101 27 27
Malaysia 12.0 100 100 0
Austria 11.5 200 196 101
FR Yugoslavia 10.0 0 0 0
France 9.3 142 125 118
other bilateral 164.2 126 85 57
TOTAL BILATERAL 1,077.1 94 60 40

ALL DONORS 1,894.4 98 62 38

Source: EU/World Bank (1996a), Annex 1.

26
Donor-related issues

C.2 Political conditionality viability of the infrastructure to be rehabilitated


depends on the reintegration of the Federation
A critically important element in the equation of and RS components, their continued separation
donor financing has been direct and indirect represents an important obstacle to achieving
political conditionality. Aid commitments have the objectives of such aid. Moreover, the nature
been seen by donors as an important means of of the support required depends critically on
applying pressure on the various political whether one integrated or two separate systems
factions and authorities (most notably in RS) to are being supported. To design rehabilitation
secure progress on the implementation of the on the basis of two independent systems would
Dayton Agreement. While it has not been wholly not merely provide implicit backing for their
successful, the actual or implied threat of separation, but would entrench the separation
withholding funding seems to have had some in practical terms.
effect in terms of political progress; and without In other areas, political conditionality has been
it, it is unlikely that even the current level of less effective. For example, while donors were
cooperation would have been achieved. successful in securing the removal of Radovan
Political conditionality has been applied to Karadzic and Ratko Mladic from public office,
various issues. Probably the clearest, as well as there is little prospect of their extradition to face
the most important, has been on the formation the Hague war-crimes tribunal. Conditionality
of national institutions. The RS authorities have on the freedom of movement and the return of
no real political commitment to BH, or to refugees and displaced people appears to have
cooperation with the Federation. Left to been given less weight by donors, and has had
themselves, they would therefore be unlikely to minimal effect.
cooperate to construct institutions at the There is a potentially important cost to
national level. On the contrary, they have every political conditionality. Not only does it give rise
incentive (and, given the level of decentralisa- to delays in disbursements, it also skews the
tion, every opportunity) to undermine the pattern of disbursements between Entities; and
prospects of reunification by adopting policies this applies particularly where, as at present, its
inconsistent or incompatible with those of the application is asymmetric. The main aim of
Federation. It may be possible to push them political conditionality, from the donors' pers-
some way towards cooperation by the threat of pective, is to influence the policies of the RS. But
withholding financial support. the result has been that only a tiny proportion of
In some areas, political conditionality has total aid flows have reached RS. (See Section
been directly relevant to particular projects. C3.) While this could be effective in putting
This applies particularly to infrastructure pressure on the RS authorities, if economic
rehabilitation projects, where donor support recovery in RS were jeopardised, it could
has been conditional on the linking of infra- equally well strengthen the political position of
structure between the two Entities. Where the the extremists.

Dilemma 1: Political conditionality


Some form of political conditionality is necessary necessarily be assumed that the RS authorities
for donors. Providing support to all parties irres- will comply with political conditionality, even
pective of their political actions would be an acute where they appear to have a very strong finan-
embarrassment, as it might well lead to donors cial incentive to do so. They have in the past
providing financial support to policies in direct proved very stubborn in the light of donor
contravention of the Dayton Agreement. It has threats, not least in the case of extradition. Even
also proved to have some (though by no means if conditionality is successful in promoting
complete) success in influencing policies and pro- cooperation, if this is forced on die RS authorities
moting the implementation of the Dayton terms. byfinancialthreats without any genuine political
However, some caution is needed in the commitment, it is likely to be superficial: it may
application of political conditionality. It cannot be possible to ensure the creation of national

27
The IMF, the World Bank and economic policy in Bosnia

Dilemma 1: Political conditionality (continued)


institutions, but it would be difficult to ensure a with other political conditions; it would risk
constructive and cooperative approach within reinforcing the perception of the donors as
them (as Muslim/Croat relations within the biased towards the Federation; and it would
Federation demonstrate). Only in the long term slow recovery and worsen living conditions in
could this be expected to contribute to political the RS. All these factors would contribute to
progress, and then only if there were a shift perpetuating extremism.
towards more moderate political leadership in Conditionality based on the return of
both Entities. refugees and displaced people is arguably a case
Moreover, an over-zealous application of in point. The obstacles to return arise as much at
political conditionality could result in inade- the popular level — the fear of violence and
quate financial support to reconstruction and intimidation — as they do from the actions of
economic recovery, particularly in RS. This the authorities. To impose political condition-
would have a direct negative effect on the ality based on the rate of return, when this is
economy, and thereby on living standards; largely beyond the control of the authorities,
and this, coupled with the opportunity to would have little effect. In fact, to the extent that
allege 'persecution' by the donors, would living conditions were worsened by die with-
provide considerable ammunition to political holding of aid, die (social) obstacles to return
extremists. 'All-or-nothing' political condition- would be increased. Any condidonality in this
ality, if its requirements were seen by the area should be confined to specific adminis-
authorities as excessive, could lead the RS to trative and policy measures.
turn their backs on the Dayton process, and The question of war criminals is more
look to Belgrade for support instead. The very difficult. There may be a case for conditionality
low level of disbursements to RS so far suggests on the extradition of Radovan Karadzic and
a real possibility of movement in this direction. Radco Mladic, if they are seen as retaining
It is also possible that the RS authorities may positions of influence with the RS authorities.
have an incentive to derail or delay some However, this is a matter of political judgment,
particular aspects of donor support (eg die IMF on which views differ. In other cases, economic
programme; see Section B3). In such cases, and political considerations would appear to
political conditionality may simply provide suggest that conditionality should not be
them with an opportunity for doing so. applied, at least for the present, as the costs
This suggests a need for carefully graduated would be greater than the benefits. It must be
political conditionality, so that the amountof aid stressed, however, that considerations of
received depends on the extent of compliance, natural justice also need to be taken into
as against an all-or-nothing approach (however account (and not only because of their political
tempting the latter might be to donors). importance to donors). The relative import-
Conditionality should also be selective, prioritis- ance of extradidon for political reconciliadon
ing those areas which are of greatest importance is likely to increase as (or if) other problems are
to the peace process, which are also within the resolved.
control of the authorities. This suggests that the Overall, donor policies on political condition-
creation of national-level institutions and die ality seem broadly appropriate. There is a risk
reunification of infrastructure should be regard- diat they are erring on the side of under-
ed (as they are at present) as high priorities. funding RS, but this issue is well recognised, and
Unnecessary conditionality, or conditioning it is expected that disbursements to RS will
of aid on factors not fully within the control of increase substantially in 1997. However, it will
the authorities, would be counterproductive, be important to keep this issue under review, to
and should be avoided. It would reduce the maintain a realistic assessment of what can be
amount of aid the authorities would expect to achieved, and to proceed with considerable
receive, weakening their incentive to comply caution.

28
Donor-related issues

C.3 The distribution of donor a reduction in employment of about 5-6,000


jobs for the two years of the project, and a
funding small reduction in real wage levels as a result
A greater problem than disbursement delays of the lower demand for labour.
has been that of financing gaps for particular • There has reportedly been a substantial short-
programmes and components of programmes. fall in cofinancing for the Emergency Social
The availability of donor funding and the rate of Fund (ESF), although this is difficult to evaluate
project implementation have varied consider- as figures for ESF financing are not provided
ably between sectors, as shown in Table 4. While separately by the Bank. The entire of the $44m
some areas of support (for example, housing and fund was to be financed by other donors;18 and
'government and social') have been over-sub- at the time of approval, only $13.6m of this
scribed relative to the original estimates of require- had been committed (World Bank, 1996c, p29).
ments, others have faced serious shortfalls.
Because of the nature of some of these • Commitments to the health sector amounted
shortfalls, there is a risk that this could substan- to $83m, 43 per cent less than the estimated
tially worsen the social impact of the reform needs of $145m (EU/EBRD/World Bank,
process. 1996, pi32). A particular gap has been in the
area of health workers' salaries, where no
• As of November, none of the expected $31m significant support has been provided,
cofinancing from non-Bank-administered although 'most health workers are paid
funds for the Emergency Public Works and insufficient salaries' (ibid, pi 37).
Employment programme had materialised,
suggesting a reduction in the scale of the The effects of these shortfalls are discussed in
project of more than two-thirds. This implies Sections El (EPW and ESF) and E3 (health).

Table 4: Financial requirements, commitments, and project


implementation by sectors, October 1 9 9 6
Commitments Implementation Implementation
as%of as%of as%of
Requirements Commitments Requirements
Infrastructure
Electricity/Coal 85 75 64
District Heating/Gas 35 55 19
Telecommunications 17 31 5
Transport 51 58 30
Water 60 66 40

Productive Sectors
Agriculture 65 96 62
Industry/Finance 140 53 74

Social Sectors
Education 118 63 75
Government/Social 136 78 106
Health 58 42 25
Housing 165 78 129

Miscellaneous
Landmine Clearance 61 52 32
Peace Implementation n/a 89 n/a
Balance of Payments n/a 84 n/a

Notes: All figures are approximate, being based on figures transcribed manually from EU/World Bank (1996a), Chart 1 .

29
The IMF, the World Bank and economic policy in Bosnia

Figure 2: Ethnic distribution of aid projects in implementation,


October 1996

Bosniac Croat Serb

National and Inter-Entity $165m

RS $24m

Federation:
General/Multi-Canton $462m

Federation:
Mixed Cantons $137m

Croat Cantons $27m

Bosniac Cantons $361m

Source: Ell/World Bank (1996a), Annex 3, Table 2.C

Other particularly acute shortfalls in funding The regional distribution of disbursements


commitments have occurred in telecommunica- has also been strongly skewed. This is illustrated
tions (83 per cent) and natural gas (69 per cent). in Figure 2, in which the area of each block is
In the former case, the problems have been proportional to the amount of aid. Only about 2
largely a result of the lack of progress in per cent of projects being implemented as of
reunifying the national network. October 1996 were in RS, with a similar

30
Donor-related issues

proportion in Croat cantons in the Federation. This applies particularly to NGOs, which in
Most of the aid from which Serbs and Croats some cases fail even to inform the authorities of
benefited were at the national level or (for Croats) their activities. This complicates the planning
to the Federation or mixed cantons — that is, it process, and results in geographical imbalances
represents their notional shares of aid provided in social provision. If the projects established
to administrative units in which the Bosniacs are were ultimately to be continued with govern-
also represented. It seems quite possible that the ment resources, it could also skew government
benefits of such aid are skewed towards Bosniacs; budgets towards those areas favoured by NGOs
and, to the extent that it is aimed at promoting in the future. This could, in principle, contrib-
reunification and cooperation, this may be seen ute to increasing tensions within or between
as furthering a primarily Bosniac objective. Entities.
Some skewing of aid towards Bosniac areas is This situation is now improving; and the
justifiable in economic terms, to the extent that budget problem, at least, should be eased by the
it is here that the physical damage, human costs, Federation authorities' intention that NGO
and economic disruption caused by the war projects should ultimately be taken over by local
were greatest. However, the extent to which the NGOs rather than by the public sector. Nonethe-
aid is skewed seems less clear-cut, since the less, NGOs should, where necessary, increase
economic situation in RS is now no better — and their consultation and coordination with the
may well be significantly worse — than in
relevant authorities; and the lesson should be
Bosniac areas.
learned for the future.
There may be important costs from a political
More generally, there is a certain feeling of
point of view. Firstly, the almost exclusive focus
of aid on Bosniac and part-Bosniac adminis- suspicion with regard to the motivations of both
trative units risks compromising perceptions of NGOs and official international agencies. Many
political neutrality on the part of the donors. are seen in some quarters as having hidden
This could weaken the legitimacy of their agendas of one kind or another (particularly,
attempts to influence the political process. but by no means exclusively, religious-based
Secondly, the minimal levels of financial NGOs); and both types of organisation, and at
support to the RS and to the Croat cantons least some of their staff, are seen as being moti-
means that their authorities are likely to see little vated by financial rather than purely altruistic
financial incentive to comply with political motives. The high salaries they pay (by local
conditionality. This could seriously jeopardise standards) contribute to this problem, as does
the whole political process: quite simply, the the habit of flying in expatriate consultants (at
Serb and Croat authorities may see little reason even greater cost), often to perform tasks which
to comply with the political objectives of could have been done (and in some cases are
agencies they believe to be siding with their seen as already having been done) equally well
opponents, and little to lose by failing to do so. by locally-recruited personnel. Officials, at least
and quite possibly many ordinary people, are
acutely aware that the cost of all this comes out of
C.4 Donor coordination and the funds pledged by donors, so that the more
NGOs extravagant foreign agencies are, the less
reconstruction gets done.
A third donor-driven problem arises from the The tendency of some NGOs to go their own
failure of donors to coordinate their activities way, without consulting or informing the rele-
effectively with the authorities. According to the vant authorities, does nothing to help, particul-
BH Minister for Foreign Trade and Economic arly in a country with a strong bureaucratic
Relations:
tradition. The fact that international agencies
Overall reconstruction coordination is still not were virtually absent from Bosnia until the last
satisfactory. The donor sector task forces still operate few years (in contrast to many poorer post-
too much in isolation from the Government. conflict countries) probably also contributes to
(Muratovic, 1997, p4) this problem.

31
D. Economic policies

D.I The Central Bank as than an appreciation of the nominal exchange


currency board rate during the reconstruction phase, any real
exchange rate adjustment would have to take
Macroeconomic policy for the whole of BH is place through price inflation.
largely dictated by the requirement of the This is not, in itself, a very serious problem. A
Dayton Agreement that the Central Bank should real exchange rate appreciation will only be
operate (for the next six years) as a currency necessary if the economy approaches full utilisa-
board. As noted above, this means, in effect, that tion of capacity; and this seems unlikely over the
currency can be issued only against the Central three to four years of the reconstruction pro-
Bank's holdings of foreign currency; and this in gramme. (See Section El.) Moreover, if the capa-
turn prevents the authorities from running a city constraint is reached, and a real appreciation
budget deficit, unless it is financed by foreign is necessary, this will occur, as excess demand will
loans or grants. It also means that the currency is push up prices for non-tradeable goods.
convertible (ie that there are no restrictions on A much greater problem will arise when the
buying or selling foreign currency), and that the effect is reversed: in order to achieve a real
exchange rate is fixed (at 100 Dinars to 1 depreciation as reconstruction aid winds down,
Deutschmark), with no possibility of adjusting it inflation would have to be lower than in
up or down. Germany (since the currency is fixed against the
This arrangement is not unique—Argentina, Deutschmark). Even with zero inflation, the rate
for example, has operated a similar system since of real depreciation would be inadequate.
1991. Its main advantage from an economic This means, that, during the later stages of
point of view is that it provides a much higher reconstruction (say from about 1999 onwards),
level of confidence in the currency, both locally either domestic policies would have to be so
and internationally, than would be likely with a deflationary as to achieve a strongly negative rate
more discretionary arrangement—anyone who of inflation, which would severely depress ou-
holds Dinars knows that he or she can exchange tput, increase unemployment, and reduce real
them at any time for Deutschmarks at a fixed incomes; or the exchange rate would become
exchange rate. Together with the tight constraint increasingly over-valued, making exports and
it imposes on monetary policies, this means that domestically-produced import substitutes less
the arrangement is very effective in keeping competitive, which would result in faster accum-
inflation down. (Hence its use in Argentina, ulation of foreign debt or, if financing were not
after the inflationary problems of the 1980s.) available, a foreign-exchange crisis.
The currency board approach raises some Since unemployment will almost certainly
potential problems, in particular through the still be very high at this stage (see Section El),
limits it imposes on exchange rate policy (World the former option would imply an extremely
Bank, 1996a, pp 17-19). Normally, one would high social cost. Apart from the general role of
expect to find a real appreciation of the exchange worsening social conditions in exacerbating
rate during reconstruction, as the large-scale aid ethnic and political tensions, the effects of
inflows increase the supply of foreign exchange. deflation would be seen as directly attributable
As reconstruction progresses, and the associated to the national institutions. It seems almost
aid inflows fall, the appreciation would be certain that this would be used by Serb
reversed, and the exchange rate would fall. nationalists as a further argument for secession
However, under the currency board arrange- — and it could be a fairly convincing one. The
ment, the exchange rate cannot be adjusted in same might also apply on the Croat side.
this way — instead, real exchange rates adjust Certainly, the effect on the very fragile cohesion
themselves through price changes. Thus, rather of the BH state would be extremely destructive.

32
Economic policies

The second option — allowing the exchange exchange to match the value of base money (ie
rate to become over-valued — might therefore notes and coins in circulation), and not, for
appear more attractive. However, this is at best a example, bank deposits. While it would in
temporary solution; and the scope for taking theory be possible to require the currency board
this path will be critically dependent on Bosnia's arrangement to operate against the total stock of
debt situation. There would again be a cost in money (including bank deposits), 'this would
terms of employment, as export and import- effectively mean a shutdown of the banking
substituting industries would be less able to com- system' (World Bank, 1996c, pi8).
pete than with a more competitive exchange rate. With the narrower system, a general loss of
The over-valuation option is only viable to the confidence domestically would create serious
extent that the country is able to borrow inter- problems. If people try to withdraw their bank
nationally to finance its balance of payments deposits and convert them into foreign exchange
deficit. If it already has an unsustainable level of as well as their cash holdings, 'the authorities
debt, creditors will be unwilling to lend. More- have only two options...: they can try to block the
over, their reluctance will be greatly increased deposit withdrawal or refuse the exchange of
(and the sustainable level of debt greatly reduced) money, that is, they can choose between a bank-
if creditors see the country's debt-servicing capa- ing crisis or a foreign exchange crisis' (World
city as being compromised by institutional Bank, 1996c, pi 8).
arrangements which prevent adjustment of an The currency board also means that the
exchange rate which is already over-valued. country will face a binding constraint on public
The problem of over-valuation could be expenditure, which can only be financed from
compounded in the event of adverse political government revenues and receipts from donors.
developments, such as rising social or political While the tax base has not collapsed to the extent
tensions. During the reconstruction phase, this to which it has in many other post-conflict
could disrupt financial flows, either because of countries, and the exceptionally high level of the
political conditionality or by impeding policy authorities' domestic and foreign liabilities would
changes or specific reconstruction projects. In make further significant borrowing both difficult
the longer term, it would represent a serious and unwise, this will represent an important
obstacle to private borrowing. In either case, the limitation on the flexibility of policy.
effect would be to reduce the supply of foreign Thus the currency board arrangement raises
exchange, and thus reduce the (notional) some potentially very serious problems.
market exchange rate; and this would widen the However, from a political perspective, it is
gap between the fixed official rate and the probably inevitable over the medium term,
notional market rate; in other words, it would precisely because of the constraints it impose on
increase the degree of over-valuation. economic policy. In the current political circum-
Adverse political developments, or the stances, a discretionary monetary policy would
perception of exchange rate over-valuation, only be viable if all decisions were made jointly
could also cause a loss of domestic confidence. If by representatives of all three ethnic groups, on
people believe that the exchange rate is over- a consensus basis. Disagreements would be
valued to such an extent that some form of down- inevitable, leading to a very damaging inertia in
ward adjustment (ie a change in the currency decision-making, which would undermine
board system) is likely, this will encourage people economic policy, macroeconomic stability, and
to convert their local currency into foreign confidence, with potentially serious knock-on
exchange, to avoid losing out. A loss of confidence effects. For example, there would be a strong
for political reasons could well have a similar temptation to resolve inter-Entity (and intra-
effect, as well as a more direct effect in making the Federation) disputes over resources by
exchange rate even more over-valued. competitive inflationary financing. In view of
In principle, people have the right to convert the extent of the needs for resources and the
their local currency to foreign exchange at the very low level of cooperation, there is a serious
mandated exchange rate. This is not an immed- risk that this would lead ultimately to hyper-
iate problem, precisely because the Central inflation, as in the former Yugoslavia.
Bank has to hold enough foreign exchange to It should also be noted that the currency
meet the resulting demand. However, currency board broadly represents a continuation of the
board arrangements generally require the policies being pursued in both Entities since
Central Bank only to hold enough foreign 1994.

33
The IMF, the World Bank and economic policy in Bosnia

Dilemma 2: The Central Bank as currency board


The currency board principle is probably the mean time might moderate political positions,
only way to ensure effective macroeconomic it is at present far from clear that this will
policy-making in a decentralised system with a happen. In any event, serious economic risks
high level of political conflict and inertia. will arise long before the currency board's six-
However, it imposes important constraints on year term has elapsed.
economic policies (specifically fiscal and In view of these problems, serious and
exchange rate policies); and it raises a serious urgent consideration should be given as to how
risk of a financial crisis after about 1999. The the political benefits of the currency board can
latter could have a major social and political be retained while minimising the associated
impact, potentially jeopardising the whole economic risks. Two options might merit
Dayton process. further (and more expert) consideration:
Abandoning the currency board principle is
not a realistic option, as it is mandated for six • A self-financing system of import tariffs and
years under the Dayton Agreement, and it export subsidies. This could be used to
would almost certainly lead to serious problems adjust the effective exchange rate through
in macroeconomic policy, either through the its effects on the prices paid for imports and
two Entities printing money competitively to received for exports. When an exchange
finance their own programmes (leading rate depreciation is required, subsidies and
ultimately to hyper-inflation), or through tariff's would be increased, averting the
complete inertia. Either would lead to a loss of problem of exchange rate over-valuation.
confidence, domestically and internationally, However, this would be at odds with the
which would be very damaging economically. trade policies currently being recommend-
Shortening the period of operation of the ed, and, in the absence of some form of
currency board might be more feasible polit- exemption, with WTO membership. This
ically, but it could only be achieved, and would option is discussed further in Section D6.
only be viable, if there were a much greater
degree of mutual trust between the various • A temporary support facility for the Central
parties than exists at present — or than seems Bank. This could take the form of a fund,
likely over the next few years. Otherwise, the financed by donors, to provide balance of
same problems would arise. Even discussions payments andfiscalsupport in the event of a
of changing the Central Bank arrangements crisis beyond the authorities' control.
(which would almost certainly be protracted) Clearly donors would not be willing to write
could seriously undermine confidence, a blank cheque: support should be grad-
increasing the risk of a financial crisis, even in a uated according to need, as determined by
relatively favourable political climate. some previously agreed formula; and the
Even ending the currency board arrange- facility would need to be subject to a fixed
ment after its six-year term could be difficult ceiling. Some conditionality on appropriate
without a substantial improvement in the adjustment measures would also be
political climate; and while elections in the required in the event of its activation.

34
Economic policies

D.2 Public finances wage-related taxes and social security contribu-


tions. (These recommendations are discussed in
The financial position of the authorities repres- Sections D4 and D5 respectively.) In 1995, these
ents a critical constraint on economic policy; two sources represented more than one-third of
and this constraint is rigidly enforced by the the authorities' total revenues in the Federation
currency board principle mandated by the (World Bank, 1996b, Table 3.1).
Dayton Agreement (as discussed in Section Dl). Because of the currency board arrangement,
The authorities, taken as a whole, will only be any reduction in revenues from these sources
able to spend what they receive, either from will feed through directly either into lower
taxation or from donors, for at least the next six government expenditure or into higher rates of
years. other taxes. It has been suggested (EU/World
While the tax base has not collapsed to the Bank, 1996b, p20) that the cut in payroll contri-
same extent as in some other post-conflict butions should be compensated by increases in
countries (for example, Uganda, Mozambique, excise and sales taxes. However, these are
and Rwanda), it has nonetheless narrowed already very high: in the Federation, they
substantially. The sales tax base had declined by represent around 16 per cent of GDP (World
about 75 per cent from its pre-war level Bank, 1996b,Table 3.1); and in RS, the general
(roughly in line with GDP) by 1995; and pay-roll rate for the goods and services tax (with some
taxes have plummeted due to the reduction in exemptions and reductions) is already 31 per
both formal sector employment and wage cent (RS, 1996, pi 13). This suggests that there
levels. As a result, BH has 'extremely limited will be little if any scope for further increases,
fiscal capacity'. At the same time the prewar and that the main burden of the adjustment will
fiscal and tax collection system has collapsed fall on public expenditure.
and been replaced by different (and incompat- The trade-off between tax rates and govern-
ible) tax systems and separate administrations ment expenditure will be particularly stark
in the two Entities (EU/EBRD/World Bank, because both customs duties and payroll taxes
1996, pl41). and contributions are ear-marked for specific
This suggests a need, firstly, to reconcile the uses. Customs duties are to be used to finance
two tax systems so that they can operate effect- the central government. Reducing import
ively within the same country; and secondly, to tariffs could thus leave a shortfall in financing
increase revenues sufficiently to meet the for the central government (unless it is fully off-
country's financial needs. set by a reduction in external debt-service
The development of compatible taxation payments); and this could substantially weaken
systems in the two Entities is problematic in the forces for political cohesion. Pay-roll taxes
itself. The RS authorities, in particular, because and contributions are the sole source of financ-
of their separatist aspirations, have every ing for pensions, benefits, and health services.
incentive to ensure that their taxation (and Any limit on the rates of such taxes would
other) systems are incompatible with those in therefore also constitute a limit on social safety-
the Federation, so as to create an additional nets. This will become still more problematic
barrier to reunification of the country. There over the longer term, as the proposed transition
may be a similar temptation for the Croat from a pay-as-you-go pension system to a
nationalists within the Federation itself. system based on individual accounts will entail a
There is also a need for compatibility in the substantial increase in costs over a transition
structures and rates of taxes, particularly period of perhaps 40 years. (See Sections El
import tariffs and the proposed value-added and E3.)
tax, if BH is to operate as a single national Over-tight fiscal constraints represent an
economy. This suggests that the donors will important obstacle to effective policy-making,
have to take a very proactive role, not only in the efficient administration, and the provision of
development of tax collection and administra- high quality public services. A particular
tion systems, but also in the details of tax problem in this context is that of public sector
policies, to ensure their compatibility. salaries: donors have shown themselves willing
Strengthening the public sector finances will to finance shortfalls in other types of recurrent
be complicated by two major tax reductions (or spending, such as money for essential drugs and
constraints) being pressed by donors for reasons other consumables in the health sector, and for
of economic efficiency: on import tariffs; and on teaching and learning materials; but they are

35
The IMF, the World Bank and economic policy in Bosnia

not generally willing to contribute towards wage (1996b, p34) points out, the system 'clearly runs
costs. As a result, the tight fiscal constraints in the risk of vulnerability to the transfer from
BH limit both the numbers and the quality of below not being forthcoming'. This problem will
staff; and this represents a potential bottleneck be the more acute if, as one World Bank study
in project implementation and policy-making: suggests, 'Tax rates will need to be higher in the
Serb Republic than in the Federation to generate
While most of the Bosnian implementing agencies
the respective revenue contributions because of
have competent staff, their number is very limited,
the greater aggregate population and incomes in
and their capacity to handle a large number of
the Federation' (Foxand Wallich, 1997, pi2).-°
projects may be stretched to the limit. Furthermore,
The implications of this vulnerability are
there is competition for highly-qualified people
extremely serious: 'The state's sustainability is a
among foreign institutions located in Bosnia and a
concern in this environment, where a strong degree
growing demand coming from the private sector,
of distrust exists' (Fox and Wallich, 1997, p 11).
resulting in a salary structure that makes it hard to
keep staff in the public sector.
RS, like the Federation, itself faces a tight
financial constraint. At the same time, the RS
(EU/World Bank, 1996a, p6)
authorities have no real political commitment to
The World Bank's approach to public-sector the BH government: given the choice, they
salaries has been based primarily on raising would prefer autonomy or unification with the
salaries at the Federation level into line with those FRY. This provides them with little incentive to
in the Croat areas (and at die national level to divert resources from their own spending prior-
about 25 per cent higher), so as to attract an ities to finance the national government. In
ethnically balanced civil service. This is an essen- 1996, the RS authorities made no contribution
tial objective; but it still leaves some problems. In to the national government, and their initial
particular, the financial support for this policy budget was sent back for adjustment by the
totals only $5m, compared with an annual addi- Parliament because it envisaged expenditure 50
tional cost of $9m pa.19 This leaves die authorities per cent above anticipated revenues, with no
to find an extra $6.5m pa until March 1998, and means of financing the deficit. Further
$9m pa diereafter. Also, no support is planned for spending reduction was required because of a
the cantons or municipalities; and no account is 15 per cent shortfall in revenues (Fox and
taken of salary levels available in die private sector Wallich, 1997, pi6).
or from donor agencies and NGOs themselves. There are signs that the RS authorities
It is interesting to compare the level of remain very reluctant to fund the national gov-
support for salary supplements with the cost of ernment; and, while it is possible that this is only
providing consultants under the Emergency political posturing, this can by no means be
Reconstruction Credit. The former is $5m, to assumed. Overcoming this reluctance may well
support 2,520 staff over the two years of the require heavy-handed donor conditionality;
project's duration — an average of about $ 1,000 and to some extent this will be automatic, since a
per person-year. Almost the same amount viable national budget would be an essential
($4.53m) is allocated for some 26 person-years precondition for an IMF programme, and thus
of consultancy services — an average of for debt reduction (see Section B2), quite apart
$174,000 per person-year (World Bank, 1996a, from more direct donor conditionality.
Annex I Appendix 5). In other words, the However, it is not clear that this form of
externally-financed salary supplement for the conditionality will be effective; in fact, there
average civil servant for a year is enough to would appear to be a risk that it could prove
finance the average consultant for about one seriously counter-productive. As noted earlier,
and a half working days. it is possible that the RS authorities would see a
Another potential problem is the distribution political advantage in derailing the debt reduc-
of revenues between levels of government. The tion process, and delaying the IMF programme
most sensitive aspect of this problem is the until after June could contribute significantly to
requirement of contributions from the Entities this objective. This in turn would require no
to the national government. This is essential to more than procrastination on their commit-
the operation of the BH government, which has ment to funding the national government. More
no independent source of revenue (until such direct and explicit (and possibly heavy-handed)
time as the national parliament approves taxes donor pressure may therefore be required to
at the national level); but, as the World Bank secure a favourable outcome.

36
Economic policies

A second issue in RS is that of transfers from The problem is that there are marked differ-
the Entity level (where most revenues are ences in the levels of economic activity, incomes
collected) to the municipalities. While Serb and employment between different areas of the
nationalists dominate the Entity authorities, the country; and these differences are, to a great
dependence of municipalities on such transfers extent polarised along ethnic lines. Most Croat
provides an opportunity to manipulate the areas escaped both the worst of the direct effects
system to penalise more moderate authorities at both of the war (which afflict the Muslim areas)
the local level. There are signs that this is already and of the UN sanctions (which have severely
occurring: the authorities in Banja Luka (the affected the RS economy); and they have received
centre of the more moderate political forces in substantial support from Croatia. As a result,
RS) have 'argued strongly that [Banja Luka] is these areas have substantially higher living
receiving less than its legislated share of taxes' standards than the rest of the country (Table 6).
(Fox and Wallich, 1997, pl6). If, as seems likely, the effects of UN sanctions on
A related issue is the direct or indirect transfer RS can be reversed more quickly than the
of resources between administrative units at the destruction and disruption resulting from the
same level (for example, between the Entities or war in Bosniac areas, a similar gap could open
between cantons within the Federation). This is up between these two regions.
critically important because of the high level of In the absence of transfers between the various
decentralisation and the ethnic base of admin- administrative units, the very tight fiscal con-
istrative units. As the World Bank has observed: straints imposed by the currency board limit
as the failure of the Former Yugoslavia demon- spending within each Entity, canton, and munici-
strates, a decentralized structure is only viable if pality to the amount of revenue which can be
inter-Entity and cantonal links are mutually raised by its authorities. This would allow a much
beneficial. It is essential...that there not be too much higher level of spending (and thus of social
cross-subsidization. provision, and support to production) and/or
(World Bank, 1996b, p xx) lower tax rates in richer areas, while imposing

Table 5: Regional Economic Indicators, 1996

Source Croat Bosniac RS


areas areas
Total production
(% of pre-war) 1 85% 5-10% n/a

Industrial production 2 n/a 15-20% 8-10%


(% of pre-war)

Total unemployment (%) 1 n/a 50-60% n/a


i i
Non-agricultural
unemployment (%) 2 50% 60%
Average net wage (DM pm) 2 330 160 70

Per capita income ($, 1995) 3 1,800 500 1,000

Sources: 1: EU/EBRD/World Bank (1996), p77.


2: World Bank, 1996b, p51 (except average wage in RS: unofficial IMF estimate).
3: Fox and Wallich (1997), p3.

NB data from different sources may not be directly comparable.

37
The IMF, the World Bank and economic policy in Bosnia

very harsh financial constraints and/or higher lower in the areas with the higher rates of pov-
taxation in poorer areas. The result would be an erty), and widen the political gaps between the
increasing polarisation between the areas inhab- ethnic groups (since richer areas seldom want the
ited by the three ethnic groups. This would both encumbrance of poorer areas within the same
increase poverty (as income growth would be country).

Dilemma 3: Inter-regional inequality and transfers


In principle, the extreme inequality between wider political objectives, such as applying
the different ethnic regions of BH suggests a political conditionality to secure the level of
need for some inter-regional redistribution of cooperation necessary to the smooth func-
resources, both between the Entities and tioning of institutions. This means, firstly,
within the Federation. However, political that aid to each ethnic area must be sufficient
considerations, combined with binding fiscal to provide an incentive for compliance, in
constraints, impose a very tight limit on the order to avoid losing it;21 and secondly, that
scope for any such redistribution. it may be necessary to withhold aid from low
Given the level of inter-ethnic political income areas as a means of applying political
tensions, any substantial transfer of resources pressure (as in RS in 1996).
between administrative units of different
More generally, an explicit geographical
ethnic composition could give rise to consider-
targeting of aid, largely corresponding with
able resentment. As the World Bank (1996b, p
ethnic boundaries, could merely transfer part
xxv) has noted, 'tolerance for interregional
of the burden of resentment from other ethnic
subsidies is low, if not nil'. Once again, this
groups towards the donors. They could come
problem is exacerbated by the currency board.
to be seen more explicitly as being edinically
Since the public accounts need to be balanced
partisan, rather than merely as partisan in terms
overall, a deficit in one area is possible only if
of their preferred political outcome; and this
there is a corresponding surplus in another
could further undermine their position in
area. This makes the transfer much more
seeking to influence the political process.
apparent than if there were merely different
levels of deficits. Any country with a fiscal Aid is concentrated very heavily on capital
surplus would immediately know that it was expenditure rather than recurrent spending;
effectively subsidising those areas with deficits; and what support there is for recurrent
and, if they were areas with a different ethnic expenditure is selective, missing a number
base, this would give considerable ammunition of critical areas, such as wage costs. Capital
to political extremists. spending for reconstruction and rehabilita-
One way of circumventing this problem is by tion is helpful to the local economy, gener-
adjusting the geographical distribution of aid ating employment and providing the facilities
in accordance with local economic conditions. for renewed provision of essential services;
This is already happening in terms of the but if inadequate resources are available for
distribution of aid between Bosniac and Croat recurrent spending, poorer areas will remain
areas; but the exceptionally low levels of at a distinct disadvantage, and there may be
assistance to RS are seriously at odds with this serious inadequacies in essential public services
objective. (See Figure 2 in Section C3.) and social provision. Over-compression of
recurrent spending may also undermine the
However, there are three important
viability of investment and reconstruction
limitations to this solution:
programmes and weaken administrative
• Correcting regional imbalances is not the capacity, due to inadequacies in staffing
only criterion for the geographical distribu- levels, wages, other necessary inputs and
tion of aid. In particular, it may conflict with maintenance.

38
Economic policies

Dilemma 3: Inter-regional inequality and transfers (continued)

One possible approach to this problem would This would not eliminate potential political
be for donors to establish a fund for support of problems. It would require the initial approval
recurrent expenditure, on a regional basis. This of all parties, which would be difficult to secure
could be done using anticipated balance-of- without additional aid flows; it would mean
payments support, for example, under World skewing funds strongly away from Croat areas;
Bank adjustment loans. Resentment against and some areas would inevitably receive less
donors could be limited by basing the geograp- than they are currently expecting. However,
hical distribution of funds clearly on an explicit the use of a transparent formula based on
formula measuring needs22 (for example, income levels would at least make the rationale
providing funds in direct proportion to the of the process explicit, and the use of aid flows
shortfall of local income in the jurisdiction of rather than domestic resources would make
each administrative unit relative to the national the trade-off" between the interests of different
average). areas somewhat less acute.

D.3 Privatisation and the and frozen foreign exchange deposits held by
settlement of domestic liabilities 80 per cent of the population), failure to settle
them could have high social and political costs.
It is currently proposed that there should be a This problem does not arise in RS, where the
rapid and wholesale privatisation of the econ- authorities claim to have no such liabilities.
omy. This idea, and the outline of the approach It is proposed that state companies should sell
to privatisation, appears to originate with the off functioning assets (eg vehicles and other
World Bank, appearing in their first post-war equipment) as quickly as possible, retaining the
paper on BH (World Bank, 1995b, Chapter proceeds, before the enterprises themselves are
IV). privatised. The companies would also hive off
As elsewhere, the recommendation for non-viable operations (which would be
privatisation is partly motivated by the view that liquidated) and assets not related to their core
it will lead to a more efficient industrial sector, activities, such as workers' housing, which would
promoting faster economic recovery, while be sold where possible. The large conglomerates
limiting the cost to the public sector. In partic- would then be split into their component parts,
ular, coupled with efforts to promote the which would be privatised. The intention is that
development of new enterprises (see Section small-scale privatisation should begin during
D4), it is intended to avoid any tendency to the first half of 1997, and large-scale privatisa-
recreate the pre-war industrial sector. This tion during the second half; and that at least one
objective is entirely appropriate. (See Box 2.) bank should be privatised by the end of the year
In the Federation, at least, there is also a (OHR/EU/UST, 1997).
second motivation for privatisation: to provide There is a high level of decentralisation in the
the means for the authorities to settle the proposed approach to privatisation, at least
domestic liabilities accumulated during the war. within the Federation. Each enterprise (or com-
This linkage is important: since it is unlikely that ponent of a conglomerate) is to be sold by the
the proceeds even of the full privatisation canton or group of cantons in which it operates.
programme will be sufficient to settle all of the This is largely intended to preserve the ethnic
liabilities in full, any reduction in its scale would identities of enterprises, so as to prevent resent-
need to be matched by a reduction in the ments arising from ownership transfers
payments to holders of such liabilities; and, in between ethnic groups, or the operation of
view of the nature and spread of the liabilities enterprises by different ethnic groups from
(which include arrears on wages and pensions, those in the areas where they operate.

39
The IMF, the World Bank and economic policy in Bosnia

On the buyers' side, the proposal is that suggests that this is unlikely to be viable. The
outstanding liabilities (for example, salary and vouchers could then be used, together with cash,
pension arrears, restitutions for war damage, to buy privatised assets, including housing, and
and frozen foreign exchange deposits) should be company assets such as vehicles and equipment,
settled by issuing their holders with vouchers. as well as shares in privatised companies. In
There has been some suggestion of an additional some cases, priority may be given to bids which
issue of vouchers to the population at large, as include a cash component, or full payment in
elsewhere in Eastern Europe; but the scale of the cash may be required.
liabilities (estimated at more than DM]3bn23) There is a great deal of urgency in the
relative to the likely proceeds of privatisation recommendations on privatisation. Wherever it

Box 2: Prospects for the industrial sector


Even before the war, there were problems in the industrial sector, in terms of what was produced
and of how it was produced; moreover, the economic environment faced by the country has gone
through some important changes over recent years (as discussed in Section B1), quite apart from
the effects of the war itself.
The problems of the prewar industries extend beyond considerations of efficiency, and apply
to a number of major industries:
• The coal reserves are of relatively low quality, with a high sulphur content.
• Electricity production is based substantially on burning this coal, and is therefore very
polluting.
• The armaments industry has been particularly affected by the war, both through being
targeted for strategic reasons, and because much of the portable equipment was transferred to
Serbia or Croatia by the respective combatants. Many donors would find it politically difficult
to promote the rehabilitation of this sector; and direct financial support would be legally
untenable in many cases.
• The long-term competitiveness of the textiles sector may be questionable. While there has
been a significant recovery in this sector, reportedly supported in part by foreign investment,
this is based in part on the current very low level of wages. International competition in the
textiles sector is likely to become increasingly intense, as low-income countries seek to promote
export-oriented textile production, and as the Multi-Fibre Arrangement is phased out. As real
wages rise, BH is likely to become a progressively less attractive location for foot-loose textile
operations.
More viable sectors include light engineering and wood products. However, there will be
intense competition in these sectors from other Eastern European countries. To prosper, it
would be necessary to get ahead quickly in these sectors, and the damage and disruption
resulting from the war will be a serious obstacle in this endeavour. If, as seems inevitable, other
Eastern European countries precede BH in acceding to the EU, this will be a further set-back.
A more general problem, affecting all industrial sectors, is the displacement of skilled workers,
both externally as refugees and internally (especially between RS and the Federation and
between Muslim and Croat areas). While this problem may be eased in the long term, it will be
some time before the conditions for a general return are created; and the likely scope of any
ultimate return remains unclear. Meanwhile, the previous pools of skilled labour have been
dispersed and workers with specialised skills separated from the areas where they can be most
productively employed.

40
Economic policies

is proposed, the emphasis is always on The strong statements of the plight of socially-
completing the process as quickly as possible. The owned conglomerates is at odds with assess-
reason advanced is that privatisation will be ments made elsewhere — sometimes elsewhere
necessary for a resumption of production by the in the same documents — where a more positive
enterprises concerned (which will itself be essen- picture is presented, for example as evidence of
tial to recovery, given their importance), since the 'indicators of a revival of the industrial sector'.
government does not have the resources to
Only a small proportion of the overall industrial
finance their rehabilitation.
capacity has been damaged, and some regions have
The need for rapid privatisation is generally
been almost completely spared (Banja Luka and
supported by a strong emphasis on the severity
southern Herzegovina, for example)....[MJany
of the enterprises' plight:
plants are still relatively well-equipped with
Most of these conglomerates were...heavily serviceable machinery capable of producing and
damaged during the conflict. marketing good quality products.
(EU/World Bank, 1996b, p8) (EU/EBRD/World Bank, 1996, Box 1, p78)
The prewar conglomerates were especially hard hit Equally, the financial constraints on the
by the war.... Most of them were split between the government's ability to rehabilitate socially-
Entities, their industrial facilities have been owned enterprises arise primarily because the
damaged, and their management methods are donors are unwilling to provide support for this
inappropriate in the new market economy. purpose. This, in turn, is presumably because
(EU/EBRD/World Bank, 1996, Box 3, p82) they have a preference for the rapid privatisation
option.
However, the speed at which privatisation is
Confidential survey evidence for the donors'
expected to take place has some severe disad-
Industry Task-Force suggests a picture of the
vantages: situation of socially-owned conglomerates
• Selling off assets and enterprises quickly will somewhere between the two extremes quoted
greatly reduce the proceeds. In the current above. Of the 50 largest socially-owned enter-
situation, where the economy is still at a very prises in the Federation (ie those 'especially hard
low ebb, domestic demand is weaker than it is hit' by the war, in the Entity with the more severe
likely to be in a few years. This will sub- war damage), enterprises accounting for 35 per
stantially reduce the profitability of the enter- cent of pre-war employment had 70 per cent or
prises. At the same time, incomes are low and more of their pre-war capacity still operable in
savings in many cases depleted. This will limit 1996 — in some cases more than 95 per cent.
the extent of cash contributions to purchasing Those accounting for a further 45 per cent of pre-
assets. war employment had between 40 per cent and 65
per cent of their previous capacity.
• Where cash contributions are required or A greater problem than the damage to pre-war
preferred, rapid privatisation will skew capacity is under-utilisation of the capacity which
participation towards those with money. In remains. Of die 50 enterprises, 20 (accounting
Muslim areas, at least, these broadly include for 60 per cent of pre-war employment) were
returnees (who are, in some areas at least, operating at 20 per cent or less of their present
resented by those who stayed to suffer the capacity, while only nine (5.5 per cent of pre-war
privations of the war); war profiteers and employment) had capacity utilisation of more
criminals (who are resented even more); and than 50 per cent. Only two enterprises, repres-
employees of international agencies (who enting just 1 per cent of pre-war employment,
may be seen as profiting further from the were operating at more than 75 per cent of
policies of their employers). capacity.
• Selling off functioning company assets (unless In many cases, the capital investment
they are genuinely surplus to requirements) required to achieve full utilisation of the remain-
is likely to reduce the value of the companies ing capacity, or the restoration of pre-war
themselves, since they will ultimately have to capacity, is very limited. By providing capital
be replaced, almost certainly at higher cost. selectively to socially-owned enterprises to this
end only where the cost is DM 11,000 ($6,500) or
It is also unclear that the justification put less per job, it would be possible to generate
forward for rapid privatisation is wholly valid. nearly 45,000 jobs at a total cost of less than

41
The IMF, the World Bank and economic policy in Bosnia

DM200m ($120m). This represents a one-time transfer which could be gained in the case of
capital cost of DM4,350 ($2,570) per job — less foreign investors. There is thus a risk of
than half the cost per person-year of employ- creating an economy based on technologically
ment created by the Emergency Public Works backward and under-capitalised companies,
programme.24 The scale of the benefits could be which would substantially weaken BH's long-
increased further by expanding the scheme to term prospects.
cover smaller enterprises and those in RS.
• The weak financial position of most of the
At present, orthodox commercial lending is
population would give rise to considerable
very limited, almost entirely short-term, and
pressure to sell shares, raising the risk that the
extremely expensive, so the main sources of
market would be flooded and prices would
financing for the industrial sector are various
plummet. Once again, those with cash would
credit schemes being supported by donors such
be able to buy up assets very cheaply, skewing
as the World Bank and USAID. However, these
economic power to a relatively small elite, and
schemes are exclusively for small and medium
greatly reducing the benefits to the bulk of
enterprises and focused heavily on the private
the population (who might understandably
sector, and are therefore likely to exclude most
feel hard done by).
of the above investments. Socially owned enter-
prises are eligible for support under the World • The decentralised basis of privatisation will en-
Bank programme only if they are 'have good trench the ethnic division of ownership, imply-
privatisation potential'. ing a strong polarisation ofownership, with major
To the extent that the larger socially-owned enterprises clearly divided along ethnic lines.
enterprises are excluded from access to these (or
other affordable) funds, the result will be to Politically, there was initially some degree of
impede their rehabilitation, by limiting their ambivalence towards privatisation on the part of
ability to invest; to force them into more the RS authorities. The 1996 policy statement,
expensive sources of funding, damaging their for example, seems somewhat at odds with the
long-term financial position; and to force them objectives of rapid and near-universal privatisa-
to sell assets which may be needed for their tion and the operation of market principles:
future operation, or which might be sold in
In the sector of the economy with majority state
more favourable market conditions later. The
ownership (state corporations), the state will
overall effect will be to weaken their financial
determine prices. The essential principle governing
position, possibly to jeopardise their viability, this...is 'cost plus'....The role of the state is to 'iron
and almost certainly to reduce the proceeds if or out' losses and income between state corporations.
when they are ultimately privatised.
(RS, 1996, pp 120-1)
As well as the pace of privatisation, the mech-
anisms proposed also raise some potentially However, this now appears to have been
serious problems: resolved, and there seems to be a reasonable
degree of commitment to privatisation —
• Sale to domestic buyers through the voucher although the depth of such commitment may be
system will not provide the capital necessary to open to question.
finance rehabilitation. Enterprises will be under-
The privatisation process envisaged in RS is
capitalised and critically dependent on their
very different from that in the Federation.
ability to borrow; but the availability of
Under the Privatisation Act of July 1996, 55 per
commercial lending is likely to remain
cent of shares in enterprises to be privatised will
relatively limited over the medium term. This
be transferred to six social funds,25 which will
could represent a significant obstacle to econ-
ultimately be transformed into stock-holding
omic recovery.
companies, but will not participate in their
• Because of the war, enterprises have fallen management; 30 per cent of shares will be distrib-
several years behind in technology compared uted free to the adult population, through a
with foreign competitors; and for some indus- voucher system; and the remaining 15 per cent
tries, catching up in technology will be essen- of shares will either be offered for sale on the
tial to regaining their competitive position. capital market, or be sold to strategic investors
However, selling enterprises to domestic subject to conditions relating to business
investors is unlikely to provide the technology activities, investment, employment, and so on.

42
Economic policies

Dilemma 4: How to privatise in the Federation?


In the absence of strong domestic opposition, immediate settlement of claims for frozen
there is little reason to oppose the principle of foreign exchange deposits, either to those
privatisation for non-utility companies. Large below a specified income level, or to a maxi-
state-owned companies are present through- mum absolute amount. Settlement of the
out the productive sectors, in activities for remainder would be contingent on a settle-
which there is no strong argument for state ment of the corresponding claims on the
involvement. However, the questions of how FRY, which should be backed by the
and when to privatise are more open to debate. international community.
Domestic versus foreign investment: The
• Holders of the remaining public sector
proposed sale of enterprises to domestic
liabilities could be issued with vouchers in the
investors has some advantages: it keeps the
form of tradeable financial instruments —
control and profits of the enterprises in local
either indexed instruments widi no interest,
hands (at least in the short term), and avoids
or perpetuals27 — if possible guaranteed (by
the potentially high long-term foreign
donors) against political risk. This would
exchange cost of foreign investment. However,
allow, holders of government liabilities to
it will limit the proceeds of privatisation, the
receive compensation immediately (although
capital available to enterprises for rehabilita-
probably at much less than face value, since
tion, and the technological advantages of priv-
there would be substantial financial pressure
atisation. The proceeds of privatisation are
on holders to sell in the early stages). No
important, as a limited settlement of outstand-
vouchers should be issued to those not hold-
ing claims on the public sector will have a
ing claims on the public sector.
significant social and political impact.26
Rapid versus gradual privatisation: A very • Potentially viable socially-owned enterprises
rapid privatisation process is proposed as a which can achieve full utilisation of their
means of getting the economy moving quickly. existing capacity at relatively low cost per job
However, this will further limit the proceeds of could be reactivated immediately, using a
privatisation: in view of the low level of econ- fund established with donor funds, before
omic activity at present, and the depletion of their privatisation was considered. Others
savings, people will be less able to pay for stakes could be considered for privatisation
in privatised enterprises than might be the case immediately.
in the future. The rapid approach will also
skew the benefits of privatisation away from • Within each of these categories, enterprises
those who fared worst in the war, while a more could be further categorised according to
gradual approach could provide a wider ethnic their need for capital and technology inputs.
ownership base if freedom of movement and A 51 per cent stake in those enterprises
residence were reestablished. needing substantial inputs could be offered
Decentralised versus national approaches: for sale to foreign investors. Either the sale
The decentralised privatisation process should could be conditional on the investor fully
avoid disputes and reduce conflict, by ensuring financing the rehabilitation, this being
that each enterprise will be owned by the reflected in the price; or the investor's
majority ethnic group in the area in which it is contribution could be used to settle the
located. However, the polarisation of major government's (49 per cent) share of the costs
companies along ethnic lines (rather than of rehabilitation.
having a broad mix of ownership) is more • The remaining 49 per cent stakes in these
conducive to a separatist than a united future enterprises, together with those enterprises
for BH. not needing substantial capital or technol-
A possible alternative approach would be as ogy inputs (eg lower-technology industries
follows: which have sustained more limited war-
• The claims on the authorities could be damage) could be sold through the voucher
reduced to some extent by limiting the system when the conditions were appropriate

43
The IMF, the World Bank and economic policy in Bosnia

Dilemma 4: How to privatise in the Federation? (continued)


in terms of income levels, confidence, etc. payment of interest on vouchers, and the use of
This could (but need not necessarily) be part of the proceeds to finance rehabilitation
done on a national basis for those enter- would act in the opposite direction. It is
prises with 51 per cent foreign ownership, as therefore possible that some liabilities would
no ethnic group would be able to secure a remain (or that a greater volume of liabilities
controlling interest. If a decentralised would remain than under the current
approach were used, it would be preferable proposals) after completion of the privatisation
to wait until substantial resettlement of process. These could remain as (or, if initially
minorities had occurred, or until it was clear indexed, be converted to or refinanced with)
that this would not happen within a perpetual notes, to be redeemed by the govern-
reasonable time-frame. Cash payments ment when resources were available. However,
should be optional, and reflect the market this could be a significant financial burden on
value of vouchers. the government, which would be reflected in
other components of government spending
The implications of this approach for the (with a direct one-to-one relationship while the
proceeds of privatisation (relative to govern- currency board is in operation).
ment liabilities) are ambiguous. The sale of It should also be noted that the skewing of
stakes in some enterprises to foreign investors, benefits to those currently in a relatively strong
and the delayed sale of 49 per cent stakes, financial position would not be fully resolved,
would increase the prices received; and the as they would almost certainly be able to
limitation of foreign exchange deposit liabil- purchase vouchers at less than their face-value
ities would help. However, the indexation or in the short term.

However, the World Bank does not agree from a rapid privatisation. Moreover, a slower
with this approach. The social funds are seen as pace of privatisation is arguably more viable in
too passive; individual investors are seen as too RS than in the Federation, because the problems
small to take an active interest in the manage- of state-owned enterprises arise primarily from
ment of firms; and the stake to be offered to economic sanctions (which have now been lifted)
strategic investors is seen as inadequate to rather than from war-damage. This suggests
provide them with an incentive to overcome the that rehabilitation costs (which arise mainly from
resulting inertia. In addition, the conditional lack of maintenance) should be relatively
sale of strategic stakes is seen as unnecessarily limited, so that the financial constraints on the
restrictive, unenforceable, and non-transparent. government will not be such an important
The Bank would like to see the privatisation limiting factor; and that the financial situation of
of the social funds, consolidation of their claims the enterprises (and thus the potential revenues
in individual enterprises, and the development from privatisation) should improve fairly
of a more active role in enterprise management; quickly as recovery progresses.
the abandonment of conditions on strategic There is also a significant political dimension
investments; and a greater role for foreign to this issue. The exclusive focus of the privatisa-
investment (EU/World Bank, 1996b, p8). tion programme within RS at the Entity level
These differences are probably not insuper- suggests a consolidation of RS as a self-contain-
able, since the RS position appears to be ed economic unit. With an immediate 100 per
negotiable. However, the process of negotiation cent privatisation, ownership of each enterprise
and the passage of new legislation is likely to can be expected to extend, to a greater or lesser
delay the process somewhat. extent, throughout RS, without crossing the
The pace of privatisation is again an issue. As boundary into the Federation, or therefore to
in the Federation (if not more so), the current non-Serb investors. Once again, this implies a step
weak economic position will limit the proceeds towards separation rather than reunification.

44
Economic policies

This effect could be moderated by a phased of this process, intended to allow the develop-
(51 per cent-49 per cent) approach, to be ment of domestic sources of financing over the
completed on a BH-wide basis if and when the medium term.
political circumstances permit. The govern- SME development is seen as a major source of
ment's share of rehabilitation costs could readily employment generation, together with the
be financed from the proceeds of the 51 per cent rehabilitation and privatisation of public enter-
sell-off, since (according to the authorities) there prises. The promotion of SMEs is probably wise:
are no competing government liabilities which while many of the management and financial
need to be settled. skills required for a thriving SME sector are
However, there are two critical obstacles to currently lacking, there was a significant level of
this option: small-scale private sector activity before the war;
and in Sarajevo, at least, the SME sector has
• Since the authorities' objective is separation already recovered significantly. The manage-
from the Federation, they cannot be expected ment skills required should be developed in the
to adopt a policy aimed explicitly at reunifica- future with the help of donor-supported
tion. training courses, although the process may take
• In the absence of outstanding liabilities, the some time.
proceeds from the 15 per cent stake sold on However, there are some caveats to the likely
the market or to strategic investors will benefits of SME development. Firstly, there
contribute directly to government spending. appears to be a strong sectoral bias in SME
In view of the high expenditure needs, the development so far, at least in the Federation,
relatively weak revenue base, and the tight towards trading, retailing, and other services
fiscal constraint imposed by the currency such as restaurants and transport, with much
board, the authorities might well prefer to less activity in the productive sectors —
receive lower proceeds now rather than especially the production of internationally
higher proceeds in the future. This incentive tradeable goods. This may change over time, as
problem is much more acute because the some service-providers are reportedly
second instalment would be conditional on a diversifying into the production of goods; but it
degree of national reconciliation which could is also likely to be a slow process.
almost certainly not occur until the current An SME sector based too heavily on non-
RS authorities had lost power. tradeable services raises two important problems:
• It will be critically dependent on the state of
the domestic economy; and if declining aid
D.4 Private sector development flows, coupled with the currency board
system, lead to a severe recession within three
The long-term development strategy envisaged
to five years (as suggested in Section Dl), the
for Bosnia is based on development of the sector could be disproportionately affected,
private sector. This entails three broad compon- with knock-on effects on employment.
ents:
• It implies a substantial negative impact of
• privatisation of state-owned enterprises (as enterprise development on the balance of
discussed in Section D3); payments: within the Federation, firms
• promotion of small and medium enterprises import 60 per cent of their inputs, but export
(SMEs); only 3 per cent of their output28
• rehabilitation and privatisation of the (EU/EBRD/World Bank, 1996, p81).
banking system (as discussed in Section D5). Secondly, at least some of the SME funds
The encouragement of SMEs is partly direct, seem likely to be unduly biased in favour of the
through the provision by donors of lines of better-off. The requirement of the World Bank
credit (World Bank and USAID) and equity fund that an enterprise should have been
funds (EBRD) in the Federation. In addition, operating for at least two years before receiving
the intention is to provide a favourable environ- credit limits its use to those who have the
ment for private sector development through resources needed to sustain an enterprise for
deregulation, particularly of the labour market two years without credit.29
(as discussed in Section D6). Rehabilitation and Thirdly, there would appear to be a danger of
privatisation of the banking sector is also a part a regional and ethnic bias in the support of

45
The IMF, the World Bank and economic policy in Bosnia

SMEs. This could arise both directly and them of their existing overhang of bad debts,
indirectly. The focus of the SME support funds with a view to putting them on a sound financial
at present is strongly, if not exclusively, on the footing and privatising them where possible, or
Federation; and some funds have an explicit liquidating them where the situation is
regional focus even within the Federation, for irredeemable;
example, the USAID programme in the • providing technical assistance and other
(Bosniac) Tuzla area. The World Bank's two- support to existing small private banks;
year rule limits access to funds in areas where • 'supporting the development and growth of
the private sector was worst affected during the
new private banks' (EU/World Bank, 1996b,
war, most notably the enclaves and areas of
P9);
conflict, where most enterprises are likely to
• opening the market quickly (by end-1997) to
have been established more recently; and in
foreign competition; and
areas where the economy remains most
• developing effective mechanisms for banking
depressed, so that few people have their own
supervision.
resources to sustain enterprises.
Overall, while SME development is approp- The first of these elements is clearly
riate as an element of employment generation, appropriate. The financial situation of the
greater consideration should be given to what major banks is such that their ability to operate is
type of enterprises are being supported, in what seriously impaired; and this represents an
areas, and who owns them. It is also important important constraint on private sector
to avoid over-optimism: the potential of this development. In the long term, there is no good
sector to absorb labour is likely to remain reason to retain the banking system within the
relatively limited, at least over the medium public sector, although the appropriate pace of
term; and there is a real risk that many of the privatisation is open to debate (as discussed in
jobs created will be lost later if the sector is Section D3). The last element — improving
severely affected by the macroeconomic effects supervisory mechanisms — is clearly essential.
of declining aidflows,especially if this coincides
Support for existing small banks is less clearly a
with the period when credits are due to be
priority, but probably desirable. The small
repaid.
private banks are under-resourced and inexper-
ienced, but they provide a useful alternative
source offinancialservices. Their role will remain
D.5 Financial sector important at least until the larger banks are
rehabilitation rehabilitated. However, encouraging the devel-
opment of new private banks is more question-
The banking system faces extremely acute
able. The banking sector is already over-
problems; and this constitutes a major constraint
populated, with a total of 49 banks operating in
to the rehabilitation of socially-owned enterprises,
early 1996 (World Bank, 1996b, p52); and both
the development of the private sector, and
new and existing private banks would probably
economic recovery. An estimated 90-95 per cent
be too small to compete effectively in the long
of the assets of the banking sector are non-
performing, and the sector is divided between term — most of the current private banks have
large socially-owned banks virtually paralysed by less than DM2.5m of net capital (EU/World Bank,
this encumbrance, and small under-capitalised 1996b, p9). A shake-out of the system is likely
private banks with very limited experience of over the medium term, through a combination of
financial intermediation. The overall result is that mergers and bankruptcies. The benefits of
very litde commercial lending is available, and opening the banking sector to foreign compet-
what there is is short-term and at very high real ition — or at least of doing so immediately — are
interest rates (2-6 per cent per month). also debatable.
The World Bank (1996b, p58) presages a
In view of the private-sector orientation of the
current economic strategy, this makes banking difference of view with the authorities on the
sector rehabilitation a high priority. This is to be nature of the financial sector. The Bank antici-
based on five main elements: pates that the authorities will opt for a universal
banking system, in which the same financial
• the rehabilitation and restructuring of the institutions provide the whole range of financial
large state-owned banks, including relieving services (insurance, for example, as well as

46
Economic policies

deposit-taking and lending), partly because this Bank argues that this option is inappropriate to
is in line with the situation in Western Europe, BH, because it 'may create major regulatory
and may thus be seen as contributing to BH's difficulties'. There seems little reason to
ultimate accession to the EU. However, the question this judgement.

Dilemma 5: Free Entry for Foreign Banks?


It is proposed that the banking sector should before these steps were accomplished would
be opened to foreign competition as quickly as raise the risk of widespread bankruptcies —
possible, as a means both of increasing the especially among the small private banks —
efficiency of the sector (through competition) leading to a largely foreign-owned financial
and of improving access to credit and financial sector in the future. This is unnecessary, and
services for the productive sectors. less than ideal from a long-term economic
At present, it seems very unlikely that the perspective. The collapse of much of the small
domestic banking sector would be able to cope bank sector would also largely negate the
with international competition — particularly benefits of donor support to small banks.
if new entrants were to cross-subsidise their There is an argument for a substantial delay,
operations initially as a means of breaking into of perhaps three to five years, in opening the
the market. Foreign competition during the banking sector. However, this would reduce
rehabilitation and restructuring of the banking the availability and increase the cost of credit
system could seriously weaken the domestic and financial services to productive sectors
financial sector, to the detriment of develop- during the critical reconstruction phase, which
ment over the longer term. in turn would have some negative effect on
From the point of view of the banking sector, employment.
a more considered pace would seem There is no obvious answer to this problem.
preferable. This would provide a breathing- It is necessary to make a judgment between the
space for the large banks to re-establish short-term economic and social benefits of an
themselves post-restructuring, and for the immediate opening of the market (which
smaller banks to strengthen their operations would have longer-term knock-on effects
(with donor support) and consolidate their through health, education, and political
market position (through mergers). Exposing stability), and the more direct long-term
banks to the full rigours of foreign competition benefits of deferment.

D.6 Trade policy observed). However, the immediate reduction


of tariffs to a standard 8 per cent raises import-
It is proposed that all administrative restrictions ant political issues. It is also less clear-cut in
on imports should be abolished, and that import economic terms (because of the direct effect on
tariffs should be levied at a standard rate of 8 per government expenditure under the currency
cent. Apart from the usual arguments about board system), and is arguably based as much on
removing economic distortions, the proposal is ideology and presupposition as on the realities
justified by the intention to join the WTO; and of the Bosnian situation.
the objective of ultimate accession to the The political dimension arises because the
European Union. A potentially significant current level of tariffs appears to be significantly
constraint on trade policy is the recent free- higher in RS than in the Federation. In RS, the
trade agreement with Croatia, which limits the average rate is 15 per cent, with substantially
scope for protectionist policies. higher rates for imports classified as 'luxury
The removal of administrative restrictions on goods' (RS, 1996, plOO); in the Federation, rates
imports is unproblematic (assuming that the vary between 0 per cent and 20 per cent
basic requirements of health and safety are (World Bank, 1996b, p25). If this is the case, the

47
The IMF, the World Bank and economic policy in Bosnia

unification of rates at a lower level would imply unless distrust or national solidarity were suffic-
a greater fiscal cost to RS than to the Federation. ient to overcome this, the RS authorities would
In any event, the RS authorities appear to face a substantial loss of revenue as a result.
have little desire to reduce tariffs, in view of the They may be forced to match the Federation's
current tight fiscal constraints. They also appear tariff levels; but, to the extent that they are able
to envisage at least the possibility of introducing to, they may prefer the alternatives of obstruct-
new trade barriers in some circumstances: ing the free movement of goods and fostering
distrust and anti-Federation solidarity.
Restrictive measures and import limits, as well as
The immediate needs for low and uniform
customs tariffs will not be introduced without a
tariffs are relatively limited. The potential
detailed assessment of domestic costs and resources
benefits of WTO membership are small; and, as
and effective protection levels.
discussed above, the prospect of even starting
(RS, 1996, pi 19)
the laborious process of EU accession remains
The operation of different trade regimes distant. There could also be some economic
between the two Entities would raise substantial benefits from maintaining (temporarily) a
problems. If there is free movement of goods, moderate level of protection, on a selective basis,
there will be a strong incentive for importers in in the form of higher import tariffs — although
RS to import goods through the Federation, in there are some potentially important trade-offs
order to benefit from the lower tariffs; and involved.

Dilemma 6: Trade policy


Virtually the entire BH economy is at present under the currency board, as discussed in
made up of 'infant industries' and 'conval- Section Dl. Trade liberalisation has an effect
escent industries'. This would suggest that there similar to a real appreciation of the exchange
may be a case for the maintenance of a moder- rate (hence the need for accelerated devalua-
ate level of protection through tariffs on non- tion during trade liberalisation in countries
essential consumer goods for a strictly limited facing serious balance-of-payments constraints);
period, to help the development of small and and a real appreciation is desirable, but not
medium private enterprises in import- achievable, during the reconstruction phase.
substituting sectors, and the rehabilitation of Conversely, to liberalise imports as aid flows
socially-owned and newly-privatised enterprises, are reduced over the medium term, when a
by offering them a breathing-space before they real devaluation is desirable, would appear to
face the full rigours of foreign competition. be at odds with real exchange rate objectives.
Such protection would also provide an In practice, however, the distinction does
additional source of government revenue, not appear to be so clear-cut. Significant real
helping to ease the very tight constraint on
appreciation of the exchange rate would only
public sector spending and allowing a faster
occur during the reconstruction phase if the
reduction in wage-based taxes and contribu-
tions. It could also help to ease a source of capacity constraint were reached, which
political dispute between the two Entities, by appears unlikely. (See Section El.) Even then,
bringing Federation policies into line with maintaining or increasing the level of protec-
those of RS. The potential for economic tion would merely enable a faster rate of
distortions could be limited by phasing out the accumulation of foreign exchange reserves, or
tariffs over time, according to a rigidly- slow down the accumulation of external debt.30
imposed schedule established at the beginning Reducing tariffs over time would imply a
of the process, reflecting the expected timing (perverse) real appreciation of the exchange
of a return to full capacity-utilisation. rate, as aid flows decline, and a real
At first sight, this might appear to compound depreciation is required. However, this effect is
the problem of exchange-rate adjustment mitigated by three factors:

48
Economic policies

Dilemma 6: Trade policy (continued)

• the level of the real exchange rate would benefits in the form of employment. The
throughout be lower (and thus the balance negative effect on exports generally associated
of payments stronger) than under the with protection should be limited, as it arises
immediate liberalisation option, ending up largely from upward pressure on the nominal
at the same level at the end of the process; exchange rate, which cannot be reflected in
actual rates under the currency board system.
• to the extent that producers benefited from If there were thought to be a significant neg-
the breathing-space offered by temporary ative effect on exports, this could be countered
protection, and thus achieved a higher level by a system of export subsidies at a rate no
of production of import substitutes (or were higher than import tariff levels. Since the trade
in a stronger position to move into export balance is likely to remain substantially in
production), the balance-of-payments posi- deficit for the foreseeable future, the net effect
tion would be strengthened for a given real on the public finances should remain positive.
exchange rate, and a higher real exchange To limit the distortionary effect, it would be
rate would thus be appropriate; and critical to ensure that higher tariffs were
• the reserves accumulated during the earlier genuinely temporary, and the schedule for their
part of the process would provide an reduction strictly adhered to. This often proves
additional cushion, to finance a current- difficult; and in BH could be a particular prob-
account deficit; and any reduction in the lem if the benefits of protection were signifi-
accumulation of debt would improve the cantly skewed in ethnic terms." There appears
current-account deficit by lowering interest to be a need for the schedule of tariff reduction
payments. to be embodied in entrenched (ie unchange-
able) legislation. However, the general aspira-
After the six-year period for which the
tion to membership of the European Union
currency board is mandated, if the political
would represent an increasingly strong
circumstances were conducive, it would be
possible to adjust the exchange rate if necess- incentive for tariff reduction, as the prospect of
ary. The mitigating factors noted above should accession came (at least slightly) closer.
at least delay the point at which over-valuation There is a critically important caveat to any
of the real exchange rate occurs, reducing the automatic process of import liberalisation
likelihood of a financial crisis in the interim. through entrenched legislation. Whatever the
A second caveat is the argument that merits of this particular case, allowing the
protection would give rise to a distorted set of authorities to pass entrenched legislation
economic incentives, encouraging production would create a precedent; and could allow the
of goods which could be imported more present nationalist leaderships to tie the hands
cheaply, and discriminating against export of future moderate authorities. Even with the
production. However, while the economy is requirement of consensus, this could create
operating far below full capacity, over-produc- serious obstacles to a long-term political
tion of import substitutes would do little eco- solution, unless there were some form of
nomic harm, and could bring substantial external control or constraint.

49
The IMF, the World Bank and economic policy in Bosnia

D.7 Labour market deregulation the former Yugoslavia was widely seen (not least
by some Bosnians) as 'living beyond its means'.
As noted above, part of the strategy for the Bosnia's means are now more limited than ever;
development of the private sector and the and it is not realistic to expect the high wage-
creation of employment is the liberalisation of levels and long holidays which existed before
the labour market, so as to remove an obstacle to the war to be reinstated. Neither is it realistic, in
SME viability and to encourage enterprises of all the current state of economic uncertainty and
sizes to take on more employees. Liberalisation change, to expect employers to take on staff
is also intended to discourage the diversion of whom they cannot later shed (or only at a
economic activity into the informal sector, which prohibitive cost); and, with the current
would both remove workers from even the most exceptionally high level of unemployment, an
basic protection, such as health and safety artificially high minimum wage would merely
provisions, as well as reducing the tax base. add to the problem, making any kind of social
This policy encompasses three main safety-net unviable.
elements: Lowering tax rates is probably also necessary.
At present, well over 50 per cent of the gross wage
• the removal of restrictive regulations on is taken up by taxes and social contributions; and
employment contracts (eg those making it this is likely to be a significant impediment to
difficult and/or expensive to fire workers, employment. It is argued by some that a
requiring very favourable annual leave reduction in rates could actually have a positive
arrangements, etc); overall effect on the public-sector finances, by
• lowering minimum wage rates, or removing encouraging more formal-sector employment
them altogether; and (and thus broadening the tax base) and reducing
• lowering tax rates on wages (including emp- the need for expenditure on unemployment
loyer and employee contributions for state benefits and other social safety-nets. However,
pensions, unemployment benefits and health this view is probably exaggerated.
services). In all three aspects, the question is how far to go;
It seems fairly clear that some movement in and the details of these policies are as yet too vague
this direction is necessary. Even before the war, to assess whether they are likely to go too far.

Dilemma 7: Labour market deregulation


A case could be made for making the reduction and working conditions. In the short term,
of minimum wage levels and deregulation of while unemployment remains exceptionally
contracts temporary, mandating a progressive high, this would not be appropriate: the effect
increase in minimum wages (though to a lower would simply be to increase unemployment in
level than pre-war) and a reintroduction of the poorest (ie RS and Bosniac) areas. Low
(less restrictive) regulations on dismissal, wages will be necessary to off-set the costs to
annual leave, etc over time. This would offer employers of the worse economic conditions.
the prospect of a gradual restoration of living As unemployment falls to more normal levels,
standards, subject to the inevitable constraints however, the risk of bidding-down would be
of political stability and economic perform- increased; and there would be considerable
ance. scope for resentment in Croat areas at losing
To the extent that the two Entities (and the jobs to low-wage workers elsewhere in BH.
two parts of the Federation) continue to Ultimately, if Bosnia were to accede to the
operate as largely separate, competing EU, it would need to accept the provisions of
economic units, gradual re-regulation could the Social Chapter. An appropriately-designed
limit the extent to which competition took labour-market re-regulation could lead up to
place on the basis of bidding-down real wages this gradually.

50
Economic policies

Dilemma 7: Labour market deregulation (continued)

However, there are some important caveats: labour market prospects of the two Entities
(and of the two parts of the Federation) may
Potential investors (foreign and domestic) be very different, the prospects of a satis-
could be deterred by the prospect of having factory agreement on re-regulation being
to increase wages and improve contractual reached at the national level are limited. It is
terms in the future. This risk could be likely that this would entail a long process of
reduced by limiting changes to newly- negotiation, which would take up scarce
contracted staff, which would also provide a administrative resources, as well as creating
disincentive to shedding staff unnecessarily; considerable potential for dispute. It is not
but investors would still anticipate an clear that this is necessarily preferable to later
increase in production costs, (albeit a more arguments about low-wage competition.
gradual one). The investors discouraged
• As in the case of trade, whatever the merits
would be those who might otherwise make a
of this particular case, establishing a
long-term commitment to production in
precedent for entrenched legislation would
BH, rather than foot-loose industries ready be unhelpful unless such legislation were
to move on once real labour costs increased subject to some form of external control.
— although the latter may also be put off if
they thought their window of opportunity
All in all, this may be an issue worth
would be reduced so far as to make considering; but it is far from clear that an
investment unviable. automatic labour-market re-regulation is
If BH is to perform well in an increasingly desirable. A more general commitment to
globalised world economy, it will have to move gradually towards provisions in line with
retain its international competitiveness over the EU's Social Chapter might be more
the long term. It will be important to ensure appropriate; but the potential for dispute and
that any re-regulation of the labour market thus for political inertia would again be
does not compromise this objective, either considerable.
through its nature or through its rate of A third alternative would be to establish a
implementation. non-entrenched schedule of changes, begin-
ning in, say, three to five years' time, leading
It would be very difficult to make a realistic
progressively from the (post-deregulation)
estimate ex-ante of the rate at which mini-
status quo to reach the standards of the EU's
mum wages could realistically be increased,
Social Chapter at the (conservatively) expected
or contractual regulations reimposed. Since
time of accession. It would be preferable to
an automatic re-regulation would probably
allow some scope for delaying the start of the
need to take the form of entrenched legisla-
process and adjusting its pace after the initial
tion passed at the outset (to overcome politi-
grace period, in accordance with the economic
cal inertia), over-optimism could be very
circumstances of the time and revised
damaging, unduly increasing unemploy-
expectations on the timing of accession.
ment.
Allowing for more detailed amendment would
Since responsibility for labour-market probably not be desirable, as this would
regulation is held at the Entity level, and the provide much greater scope for dispute.

51
The IMF, the World Bank and economic policy in Bosnia

D.8 Utilities and public services quick: for water, sanitation, and solid waste, the
objective is to recover all operations and main-
Beyond physical reconstruction and rehabil- tenance costs in three years, with full cost
itation, the intention is to reunify the public utility recovery afterfiveyears. Social-pricing mechan-
infrastructure between the Entities. Energy, water, isms (to limit the social impact) are regularly
and telecommunications systems were originally mentioned in Bank documents in this context,
developed for Bosnia as a whole, and were but only in passing. There is no discussion of the
intricately linked between the Entities prior to the types of mechanism which could be used, or of
war. They have now been effectively separated issues in their design and application.
along the inter-Entity boundary, to the detriment The desire to increase cost recovery is
of efficiency, service costs, and financial viability. motivated primarily by the fiscal constraints on
Reintegration is highly desirable from an economic the public sector — no doubt considerations of
perspective, and would be a significant step economic efficiency are also at play, but these
towards reunification. However, precisely because are not emphasised. It should be noted that cost
of the latter aspect, there may be important recovery was well developed prior to the war, so
political obstacles to movement in this direction. the perception problem which arises when fees
A second, and more controversial, policy in are introduced for previously free services
this area is to develop and extend cost recovery should not be serious.
for services such as water, sanitation, and solid- Nonetheless, there are potential concerns
waste disposal, as well as for energy supplies about the extent of cost recovery, the pace of its
(electricity, gas, and district heating). The implementation, the potential social impact,
proposed timetable for cost recovery is relatively and the regional/ethnic dimensions.

Dilemma 8: Cost recovery


There are three major concerns about the • There is also a potentially important region-
rapid and general application of cost-recovery al dimension to this issue. While the existing
policies in BH. regional disparities in income persist, the
ability to afford services will vary consider-
• While cost recovery for energy is fairly
ably between RS, Muslim and Croat areas.
uncontroversial, for some other services the
Assuming similar levels of consumption,
case is less clear. This applies particularly to
applying the same principles and targets in
sanitation and solid-waste disposal, as there
all areas would mean a much greater impact
are major public-good benefits arising from
on real incomes in the poorest (generally
their use. From an economic perspective,
Muslim and RS) areas.
this represents a strong case for subsidy.
• The social impact of increasing cost recovery These concerns would suggest a more
is a matter of potential concern. The breadth limited and/or more gradual application of cost
of cost recovery envisaged, and the relatively recovery. However, there would be a high cost
rapid achievement of full cost recovery, to such a policy: because of the tight fiscal
suggest a major escalation of basic living costs constraint, spending money on subsidising
over the next five years. While rapid infrastructure services directly reduces the
economic growth is expected, at least initially, resources available for other uses. The
the benefits will by no means be universal, potential benefits of subsidising infrastructure
and will be critically dependent on BH's services therefore need to be evaluated relative
success in employment generation, and the to alternative uses of funds.
extent and effectiveness of safety- nets. There Social-pricing mechanisms of some kind will
are serious concerns on both these issues, as be critically important, especially over die
discussed in Sections El and E2. medium term, as a means of limiting the social

52
Economic policies

Dilemma 8: Cost recovery (continued)


impact. If such mechanisms are not in place, it could ease the distributional problem without
may well be necessary to moderate the rate of an explicit regional differentiation; but
increase of charges, and to delay cost-recovery resentments could still arise if it became
targets. It should be noted, however, that social apparent that the costs and benefits of social
pricing would reduce the revenues generated pricing had a strong regional or ethnic bias.
— it may well be necessary to subsidise the There are no easy answers here. The
consumption of a large proportion of the benefits of not imposing full cost recovery for
population, at least initially. The administrative sanitation and solid-waste disposal should be
costs of social-pricing mechanisms may also be carefully evaluated, and compared with altern-
substantial. ative uses of government spending. Where cost
In view of the regional dimension, it might recovery is introduced, social pricing should
seem preferable from a distributional perspec- be included as an integral part of the policy, to
tive to apply more rigorous standards of cost protect poorer households; and it should be
recovery in higher-income (mostly Croat) areas, designed in such a way as to protect all those
in effect cross-subsidising services in the poor- who would face an excessive financial burden.
er areas. However, this could create consider- However, direct cross-subsidisation between
able resentment. Social-pricing mechanisms the three ethnic regions should be avoided.

D.9 Agricultural policies represent a large proportion of RS's total


agricultural production.
The proposed agricultural strategy is based on Pursuing different agricultural policies in the
practical support for small private farms, two Entities — particularly with regard to prices
including the provision of imported inputs, — would cause serious problems, and is not a
credit, livestock, and equipment. These policies viable option. This implies an urgent need to
include cost-recovery measures, and it is reconcile policies and priorities between the
strongly recommended that subsidisation of Entities, if this has not yet been achieved. This
agriculture should be avoided. The state-owned would be a prerequisite for a Sectoral
farms are to be privatised, as are support Adjustment Loan.
services and the production of agricultural The evolution of conditions affecting the
inputs and processing industries. Food aid is to agricultural sector over time will be critically
be phased out, to avoid undermining the incent- important, and needs to be taken carefully into
ives for domestic production and reducing account in policy design. In the short and
producers' incomes. There is also a proposal for medium term, important constraints arise from
a land bank, to facilitate the departure of landmines, and ownership disputes arising
farmers from the agricultural sector, and to from population movements, as well as the lack
allow the enlargement of the remaining plots. A of equipment and limited access to other inputs.
World Bank Agriculture Sectoral Adjustment Major concerns over this period will be to re-
Loan is expected in the near future to support absorb as much as possible of the rural labour
these policies. force into the agricultural sector at adequate
These policies appear to be somewhat at odds income levels (to limit rural unemployment and
with the policies envisaged by the RS authorities poverty and excessive pressure for rural-urban
(RS, 1996, pp 121, 123), which include, for migration); and to encourage an expansion of
example, direct state provision of veterinary food production at affordable prices, to fill the
services and credit, the possibility of subsidising gap left by declining food aid receipts. In the
producers in relatively undeveloped areas longer term, it will be necessary to improve farm
through direct grants, and 'protective prices' for incomes; to increase efficiency and international
priority products, including wheat, corn, sugar competitiveness; and to prepare the ground for
beet, oil-bearing crops, meat and milk. These ultimate accession to the EU.

53
The IMF, the World Bank and economic policy in Bosnia

These aims require very different policies in labour could contribute to rural unemployment,
some respects; and it seems possible that policies declining real wage levels, and rural-urban
directed towards longer-term objectives are migration (adding to urban unemployment rates).
being started too soon. For example, support A long-term agricultural strategy is needed.
for farm mechanisation (financing for tractors, However, uncertainties relating both to BH's
for example), and the land bank will tend to political future and to the prospects for EU
increase the size and capital-intensity of farms, accession make devising a strategy a compli-
which implies a reduction in labour use. In some cated process. Creating the conditions for EU
areas, population shifts from rural to urban membership will be an important objective; but
areas have already occurred and are unlikely to it will be important to be realistic about the likely
be reversed in the near future. However, there time-frame of accession, and to ensure the
may be other areas where the shedding of viability of the sector in the interim.

54
£. Social dimensions

£.1 Employment and the imply an unemployment rate of about 85-90


per cent. Reducing unemployment to a sustain-
Emergency Social Fund able level (say 10 per cent), while allowing a
The need for employment creation is well return of the refugees, would require an
recognised in World Bank documents. Unemp- increase in non-reconstruction employment in
loyment is described as 'an overwhelming the order of 400-650 per cent from its current
economic and social problem' (EU/EBRD/World level. Even if no refugees were to return, non-
Bank, 1996, p94), and job creation as 'absolutely reconstruction employment would need to be
essential' (EU/World Bank, 1996a, p9), 'not only doubled or trebled.
an economic necessity but...essential for peace' The relationship between population move-
(World Bank, 1996b, p xvii), 'the most important ments and employment is a two-way one. A
challenge for the economic recovery program- necessary (though not a sufficient) condition for
me' (World Bank, 1996b, pi 1), and 'an absolute the return of refugees and displaced people to
priority' (EU/World Bank, 1996b, plO). their areas of origin is their expectation that
At present, unemployment is estimated at 50- they will have an adequate income. With
60 per cent of the population of working age, pensions and social benefits likely to remain at
although it is substantially lower in the Croat minimal levels over the medium term, this will
area of the Federation. It is estimated that the require the creation of adequate employment at
reconstruction programme created some 250,000 reasonable wage rates to reabsorb the returnees
jobs at its peak in 1996 (EU/EBRD/World Bank, into the economy. Unless and until this is
1996, p94). This is equivalent to half of total achieved, displaced people are likely to remain
employment in BH during that year. If the where they are, and refugees will be returned
average level of employment generated by only by compulsory repatriation. Moreover,
reconstruction during 1996 were half of this compulsory repatriation will have a serious
level, this would imply an unemployment rate economic and social impact, not only leaving the
without the reconstruction programme in the returnees themselves (or those they displace
order of 60-70 per cent. Adjusting further for from jobs) without a viable income, but also
the effects of demobilisation during 1996-7 could increasing the strain on the budget and potent-
increase the underlying rate post-demobilisation ially reducing overall real wages by adding to
further to between 85 per cent and 95 per cent.32 the excess supply of labour.
As the reconstruction programme is This suggests that the compulsory repatria-
completed, these jobs will disappear (hopefully tion of Bosnian refugees from 'host' countries
to be replaced by jobs in running the rehabilit- will be seriously detrimental (except in the case
ated infrastructure and services). At the same of people with substantial financial or valuable
time, unemployment may be further increased human capital). It will be economically damag-
by the return of refugees, and possibly by ing; it will have a substantial social impact; and,
further demobilisation (as well as shifts in the in consequence, it could be a significant obstacle
geographical distribution of employment due to to a viable and peaceful future. Donors should
the return of displaced people). both avoid this option themselves, and put
The potential effects of population move- pressure on others to do so. They might also
ments are enormous: there are between 1.0 and consider mechanisms for sharing the financial
1.4 million refugees; and a greater proportion burden of refugees, to reduce the pressure for
of these people are likely to be of working age repatriation on the most important host
than in the settled population. If all refugees countries.
were to return, the demand for employment As discussed earlier, the strategy for employ-
could increase by more than half. Excluding ment creation is based on private-sector develop-
reconstruction-related employment, this would ment, through privatisation and the promotion

55
The IMF, the World Bank and economic policy in Bosnia

of small and medium enterprises. However, it is A fairly limited adjustment to take account of
recognised that this will not be achieved quickly; these considerations would have a substantial
and that domestic social safety-nets will be effect on the results. If the growth rate of employ-
inadequate to fill the gap in incomes for the ment were one-third lower than the World Bank
immediate future. Thus the World Bank projections for output growth (by no means a
(1996b, pi5) acknowledges that: pessimistic assumption), unemployment would
A significant share of the population will continue
remain between 24 per cent and 39 per cent in
to depend on assistance in the medium
2000; and full employment of the current popula-
term...Temporary programs are required until tion would be achieved only between 2006 and
pension, unemployment and social assistance 2010. It would take until 2019-27 to reabsorb all
systems are restarted. of the refugees into the labour market.
At present, emergency food-aid is an impor-
If the World Bank's projections for output tant form of social support. However, it is largely
growth (World Bank, 1996b, Table 5.3) prove an overhang from the war, and is being phased
correct, and employment grows in line with out by donors. The proportion of the population
output, unemployment would fall to somewhere receiving food aid is officially estimated to have
between 6 per cent and 25 per cent in 2000 reached 80 per cent in 1995, although some
(assuming that no refugees return, but allowing informed observers believe the figure to be
for 0.6 per cent pa population growth). In other much lower. The Federation authorities expect
words, there would be no scope for reabsorbing
food-aid recipients to decline to 40 per cent of the
refugees into the labour market without adding
population in 1997, 20 per cent in 1998 and less
to unemployment until at least 2001. At the
higher starting-point for unemployment, full than 5 per cent in 1999 (World Bank, 1996b, pi5).
employment of the current population would be Apart from food aid, there are two main
reached only in 2004. If the projected growth temporary programmes for income support:
rate for 2001-5 were continued thereafter, • The Emergency Public Works (EPW) pro-
refugees could then be fully reabsorbed into the gramme is intended to increase employment
labour market by 2006 on the most optimistic opportunities until private-sector employment
scenario, or 2011 on the most pessimistic. generation takes over, by providing funds for
However, these projections are fairly sensi- small, labour-intensive rehabilitation projects.
tive to the assumptions on which they are based. • The Emergency Social Fund (ESF) is intended
Moreover, as noted above, the World Bank mainly to provide a minimum level of social
projections appear very optimistic; and extra- support to the poorest households, in the form
polating the projected 2001-5 growth rate (8.4 of monthly cash payments, until the pensions,
per cent pa) into the indefinite future is almost unemployment benefit, and other social support
certainly not realistic. It also seems questionable systems are once again fully operational.
that a 1 per cent increase in output would lead
directly to a 1 per cent increase in employment. However, there are serious doubts about the
Apart from anything else, real wages are size of these programmes relative to the scale of
currently very low, and capital very scarce (at the problem; and their duration appears to fall
least in RS and Bosniac areas); and a one-to-one far short of the likely time-frame for the restora-
relationship between output growth and tion either of full employment or of benefit
employment growth would imply avoiding any payments. Both of these problems are com-
increase in either the real wage rate or the share pounded by the major shortfalls in cofinancing
of capital in total income. Apart from the for these two programmes, which will further
question about its realism, the assumption of reduce their scale and duration.
constant real wages would imply very high levels The EPW programme is, in principle, very
of poverty (and therefore a considerable need helpful, although its scale is very limited. The
for social support) for employed workers and total amount originally envisaged was $45m
their families. (It should also be borne in mind over two years, implying the creation of about
that the jobs associated with externally- 3,800 jobs for the two years of its operation33 —
supported reconstruction will be lost by 2000 as enough to reduce unemployment by less than
the reconstruction programme winds down; 0.4 per cent. If the current financing gap for this
and that demobilisation will further reduce project is not filled, this will be reduced to about
employment from the 1996 level.) 0.1 percent.

56
Social dimensions

The ESF is also very welcome, but limited in current scale of assistance aimed at meeting
terms of its coverage, the level of payments them; and that the time-frame for reducing
provided, and its likely duration. Coverage rep- dependence on social safety nets, and for the
resents less than half of the number of people return of refugees, is considerably longer than
unemployed (and is likely to include a large the World Bank appears to envisage. The
proportion of recipients not classified as unem- statement quoted above, that 'a significant share
ployed, such as those above working age and of the population will continue to depend on
dependent on pensions, orphans, and house- assistance in the medium term' does not come
holds with some employment but including close to reflecting the gravity of the situation.
members with war-related disabilities). Coupled with the very short time-frame of the
The ESF is supposed to provide monthly ESF and EPW programmes, and the rapid phasing
payments to households totalling DM5m out of food aid, this implies a choice between
(US$3m), spread between 150,000 poor house- widespread and severe poverty, or an intolerable
holds across the country, and 100,000 orphans burden on the public finances to support safety-
and war disabled in four municipalities (World net programmes for the next 20-30 years.
Bank, 1996c, pp 9, 93). The average monthly There are also potentially serious implications
payment per recipient household would thus be in the shorter term. If, as seems quite possible,
DM20. Allowing for an average household size unemployment remains at 25-40 per cent in the
of three, this implies payments of about $0.13 year 2000, and specific employment creation
per person per day, a fraction of the absolute and externally-supported social safety-nets have
poverty line ($1 per person per day at been phased out, the prospects for reconcilia-
purchasing-power parity exchange rates). tion or a shift towards political moderation
The planned duration of the ESF is only could be seriously jeopardised. This could be
twelve months; and this could be further compounded if there were a contraction in the
shortened by the substantial financing gap. The economy due to the reduction of aid flows and
funding gap has so far been filled partly by the the exchange rate rigidities associated with the
Bank accelerating its own disbursements, and currency board arrangement in 1998-9. Since
partly by the authorities diverting some of their the World Bank's growth projections (and thus
balance-of-payments support to fill the gap. the decline in unemployment) rest heavily on a
However, disbursements nonetheless seem to return to pragmatism and moderation in the
have been slowed down: as of mid-November political sphere, there is a real risk that the
1996, eight months after the Emergency whole political and economic future of BH
Recovery Project (of which the ESF forms a part) could be irrevocably compromised.
became effective, disbursements totalled only It is not realistic to assume that the donors will
DM9.4m (World Bank, 1996c, p4). This continue to fund social programmes on the scale
represents a monthly rate less than one-quarter required over the next 20-30 years. However, it
of that assumed in the last paragraph. would seem essential that programmes such as
Moreover, the Bank resources available for the the ESF and the EPW project are both substan-
ESF will soon run out; and, in view of the strict tially enlarged and extended over at least the
budget constraints imposed by the currency next five years. Only if the decline in
board, the diversion of balance-of-payments unemployment and poverty can be greatly
support puts additional pressure on other areas accelerated can there be any hope of creating
of government spending. the political conditions for long-term economic
It seems clear that there is a considerable gap growth. This raises some important questions
between employment and social needs and the about the economic strategy being pursued.

Dilemma 9: Employment creation and the economic strategy


A major part of the rationale for the current is by no means obvious that it is likely to be
economic strategy is the rapid creation of achieved within a politically viable time-frame.
employment opportunities. However, this is The question is whether a fundamentally
not being achieved at an adequate rate, and it different economic strategy would be more

57
The IMF, the World Bank and economic policy in Bosnia

Dilemma 9: Employment creation and the economic strategy (continued)

effective in reaching this objective, or whether • The jobs created directly by EPW schemes
potentially beneficial changes are limited to would be temporary, lasting only as long as
minor modifications to the current strategy. there was appropriate work to be done and
It would be possible to envisage a rather adequate donor funding to pay for it. The
different strategy, modelled in part on the longer-term benefits would be limited to the
Emergency Public Works programme. This secondary effects on employment, through
would increase the emphasis on (and donor increased demand.
support for) labour-intensive reconstruction
and rehabilitation work. There is clearly a very In practice, an approach centred on labour-
considerable amount of such work, only a intensive public works is therefore unlikely to
fraction of which has, as yet, been done. The be viable as a basis for sustainable long-term
spending of those employed in such projects growth. To have any significant positive effect,
would generate additional demand in the it would be essential to reduce the cost of EPW
economy, strengthening small and medium projects substantially. At present the cost per
enterprises and creating more (hopefully job seems unnecessarily high — 130 per cent
sustainable) jobs. more than the average net wage in Croat areas,
However, there are some important limita- and nearly five times that in Bosniac areas.
tions to this alternative: However, a detailed assessment of how the cost
could be reduced is well beyond the scope of
• Increasing support for labour-intensive
this paper.
public works could only be achieved by
increasing total aid (which would be difficult Even at a much lower cost, the argument for
to justify), or by reducing support to other increasing support for EPW is essentially politi-
programmes. If other components of the cal: as long as unemployment and poverty
reconstruction programme were substan- remain at their current very high levels, this
tially reduced (for example, institution- will be a serious impediment to the creation of
building, infrastructure rehabilitation, or a political climate conducive to peace, stability,
support to the social sectors), there would be and economic growth. It is possible — but only
a danger of compromising long-term sustain- possible — that greater employment creation
ability and other aspects of basic needs in the could shift the political process in the direction
interests of short-term employment gains. of moderation and conciliation; and that this
would substitute for the effects of those projects
• The cost of employment generation under which would need to be forgone to finance a
the EP W programme to date is very high - in major EPW programme.
the order of $5,500 per person-year. A A more limited shift in this direction (coupled
rough estimate suggests that this may be with a substantial cost reduction) would be more
only slightly lower than the equivalent figure viable. This would entail a detailed appraisal of
for the overall aid programme.34 Based on the whole aid programme, to identify those
this estimate, transferring the entire components which are, on the whole, less
financing for the reconstruction programme beneficial than support to EPW.
in 1996 would have led to a net reduction in
However, employment creation based on
unemployment of only about 3 per cent.
public works can be no more than a temporary
• The potential for labour-intensive public palliative; it is no substitute for an economic
works is much greater in the Federation policy programme designed to generate
(where there is substantial war damage) employment. The alternative approaches to
than in RS (where the main damage has privatisation and trade policy outlined in
been done by economic sanctions). An EPW- Dilemmas 4 and 6 might help to strengthen
based strategy would therefore have more and accelerate job creation under the current
limited scope in RS, so that shifting the private-sector-led strategy.
emphasis towards this type of programme
could inhibit any correction of the regional
imbalance in aid.

58
Social dimensions

£.2 Pensions and benefits Taking account of the high proportion of


workers in the informal sector, who are likely
In time, it is hoped that domestically-financed not to be paying wage contributions, makes the
social safety-nets, such as pensions and unem- situation considerably worse. In RS, only 30,000
ployment benefits, will take over from the ESF. people were employed in the formal sector in
However, this is a very long way off, and move- 1995, one per 5.5 pensioners. While figures are
ment in this direction will be very slow. not available for the Federation, the situation is
Pensions have fallen dramatically since the likely to have been broadly similar in Bosniac
beginning of the war, and at times have not been areas, but substantially better in Croat areas,
paid at all in the Federation, reflecting the where the formal sector represents a much
extreme pressures on public sectorfinances.35In greater proportion of total employment.
1996, average pensions in Croat areas were The problem is of a similar order of magni-
DM65 (US$38) per month, slightly above the
tude in the case of unemployment benefits: with
absolute poverty line. In Bosniac areas, however,
unemployment at 50-60 per cent, there are at
they were only one-fifth of this level; and in RS,
while the authorities claim that there are no least as many, and up to 50 per cent more,
payments arrears, they were 'at a very minimal people out of work than in work, overall. Again,
level'. As a result, many pensioners were (and the ratio of unemployed people to those in
still are) living in 'conditions of extreme poverty' formal employment is considerably worse:
(World Bank, 1996b, p48). assuming a 60 per cent unemployment rate,
A major contributory factor is the exception- there would have been 7.5 people unemployed
ally high dependency ratio. Because of the dispro- for every person in formal employment in RS in
portionate number of people of working age 1995. This implies that, for a pension/benefit
who left BH as refugees, coupled with the very system fully paid for from formal sector wages,
high rate of unemployment, there are nearly as each wage-earner would have had to pay for 5.5
many pensioners as there are people in employ- pensions and 7.5 unemployment benefits.
ment to pay for their pensions. Moreover, there Again, the situation is likely to be considerably
is a strong regional pattern, in that pensioners better in Croat (though not Bosniac) areas.
represent a substantially larger proportion of The ratios for Bosniac areas and to a lesser
the population in Bosniac areas and RS than in extent RS are likely to have improved signifi-
Croat areas (Table 6). This is a particular problem cantly since 1995, to the extent that formal-
because unemployment is also substantially sector employment has increased. However, the
higher in these areas: the ratio of pensioners to situation remains serious. Even on the
those in work is roughly three times as high in optimistic assumption that half of the workers in
RS and Bosniac areas as in Croat areas. the informal sector in 1995 have been

Table 6: Estimated number of pensioners relative to population


and labour indicators
Bosniac Croat Rep.
areas areas Srpska
Number of pensioners 200,000 52,000 170,000
as % of: population 12 8 14
labour force 50 25 45
total employment 95 35 115
formal employment n/a n/a 550

Sources: Numbers of pensioners and of formal sector workers in RS (in 1995) are taken from World Bank (1996b, pp 24, 26, 28).
Population and labour force are the author's estimates: overall population is based on estimates of the total pre-war population
(4.4m) and numbers of refugees (l-1.4m); and the overall labour-force (1.1m) is taken directly from EU/EBRD/World Bank, 1996,
p93. These figures are combined with the pre-war ethnic composition of the population (from Crnobmja, 1996, p22, with self-identi-
fied Yugoslavs and other ethnic groups divided pro rata between the three areas). Total employment is based on the resulting labour-
force figures, combined with rough estimates of regional unemployment rates (Bosniac areas and RS 60 per cent; Croat areas 20
per cent). It should be noted that all the percentage figures are very approximate.

59
The IMF, the World Bank and economic policy in Bosnia

reabsorbed into the formal sector, increasing formal employment to perhaps 1-1.25 in the
the formal sector's share of total employment Federation and 1.75-2 in RS. This would be a
from around 20 per cent to 60 per cent, each substantial improvement, but the ratio remains
formal-sector worker in RS would be paying for very high: in the order of 2.5-3 times that in the
1.5-2 pensions and 2.5 unemployment benefits. UK for the Federation, and 4.5-5 times for RS.
The situation in the Federation is somewhat It would also be greatly increased by any signifi-
better overall, because of the more favourable cant return of refugees; if all the refugees were
circumstances in the Croat areas. On similar to return during this period, the ratios for
assumptions (60 per cent formal-sector employ- unemployment benefits would be at least
ment, with unemployment of 60 per cent in doubled.
Bosniac, and 20 per cent in Croat areas), each The problem of inequality between Croat and
formal-sector worker would have to pay for Bosniac areas would also be moderated in this
around 1-1.5 pensions and 1.5-2 unemploy- scenario, but would remain serious even without
ment benefits. However, if the benefits system the return of any refugees. On the same assump-
were operated on a uniform Entity-wide basis, tions, and allowing for a halving of income
the inequality between Bosniac and Croat areas differentials between the two areas (from 50 per
would imply a considerable transfer of resour- cent to 25 per cent), Croat areas would make
ces between the two areas: taking account also of about 40 per cent of contributions, while
wage differentials, Croat areas would make receiving around 20 per cent of pensions and
about 60 per cent of total contributions, while perhaps 15 per cent of unemployment benefits.
receiving only about 20 per cent of pensions and The donors recognise the existence of this
12-15 per cent of unemployment benefits. This problem. The EU/EBRD/World Bank (1996)
could raise serious political problems. paper observes with reference to 1997 that
In view of the very low wage-levels, especially 'there are still significant gaps between the
in Bosniac areas and RS, the high dependency needs for protecting vulnerable groups and the
ratio and unemployment rate means that pay- revenues that can possibly be generated by the
roll contributions are very high, even at the domestic economy' (op. cit. pl45). However, the
current very low levels of pensions and benefits donors appear to under-estimate (or at least
— 17.5 per cent of wages in Croat areas and 24 they under-state) the extent of the problem; and
per cent in Bosniac areas for pensions alone. they give little consideration either to its likely
The current situation also makes for a very acute duration or to its regional dimension.
trade-off between formal-sector incomes and In the short term, the gap is to be filled by
pensions/benefits: increasing pensions by DM 1 donors. However, the level of donor support
would require an increase in the cost to formal- envisaged appears to be grossly inadequate even
sector workers of DM 1.50-2.00 in RS and to bring pensioners and the unemployed in RS
DM 1.00-1.50 in the Federation, while a similar and Bosniac areas up to the absolute poverty
increase in unemployment benefit would cost line. For pensioners alone, this would cost
around DM2.50 per worker in RS and something in the order of $80m; and the
DM 1.50-2.00 in the Federation. Since the amount needed for the unemployed might be of
average net wage in Bosniac areas is DM160 pm a similar order of magnitude. By comparison,
(about US$3 per day), any household with three the amount deemed necessary in the EU/EBRD/
or more members and only one (average) wage World Bank paper is $20m in 1997. This is
is already on or below the absolute poverty line. roughly $20-25 per unemployed or pensioned
This means that poverty among pensioners or person, making no allowance for other potential
those dependent on other domestically-financed recipients. This would represent an average
benefits can only be reduced by increasing additional income equivalent to about 6 per cent
poverty among people in employment. of the absolute per capita poverty income.
The problem is not likely to be resolved in the Taking account of dependents would reduce
near future. As noted in Section El, unemploy- this figure still further.
ment could well remain at 25-40 per cent in In the medium term, the intention is to shift
2000, even without any return of refugees. Even towards a self-financing, pay-as-you-go pension
if the share of the formal sector in total and benefit system, wholly financed from
employment could be increased to 80 per cent payroll contributions. Pensions would be based
over this period, this would reduce the ratio of on a three-tiered model, with a universal
pensioners and the unemployed to those in minimum pension, supplemented by earnings-

60
Social dimensions

related pensions (operated at the cantonal or imply a commensurate reduction in pensions


inter-cantonal level in the Federation) and below the levels shown in Table 7.
private pension schemes. The minimum
• It seems unlikely that pensions and benefits at
pension would be based initially on a fixed
absolute poverty levels would be politically
contribution per employee, and supplemented
viable for more than a very short period.
by donor funding (World Bank, 1996b, p49),
then shifted to a proportional rate, which would • Once again, it is important to note that a
be increased in 1997—8, as donor support is uniform Federation-wide system would
phased out. imply a substantial net transfer of resources
A ceiling of 15 per cent is envisaged for payroll from Croat to Bosniac areas, which could be a
contributions to the minimum pension. By 2000, source of political tension. The alternative of
even with unemployment at 25-40 per cent, this separate arrangements for the two areas
should be sufficient to provide pensions above might well imply pensions below the poverty
the absolute poverty line in the Federation. In line or wage contributions in excess of 15 per
RS, however, this may well not be the case: with cent in Bosniac areas.
unemployment at 25-40 per cent, even if 80 per
In the long term, a system based on individ-
cent of employment were in the formal sector,
ual accounts is envisaged. However, it seems
pensions would reach the absolute poverty line unlikely that this will be feasible for some
only if real wages were increased by 150-200 per decades. The transition from a pay-as-you-go
cent from their current level (Table 7).36 Such system to a system based on individual accounts
changes in unemployment and real wages would requires pension payments to continue, while
almost certainly require considerably faster contributions are set aside for future payments.
growth even than the very high rates currently The resources for pensions thus need to come
envisaged by the World Bank. from somewhere else; and it will be a very long
Four further points should be noted in this time before additional resources are available
context: on the necessary scale. There seems little point
• The initial use of a fixed contribution per in even considering this option at this stage.
employee is wholly inappropriate. This is No explicit ceiling has been proposed for
highly regressive, in that low-wage earners contributions to unemployment benefits. However,
would pay a much greater proportion of their these will need to remain very high until sub-
income than those on higher incomes. The stantial improvements in wages and employ-
absolute amounts are very large — about ment have been achieved (Table 8). In 2000, with
$3-400 per employee per year for pensions at unemployment at 2 5 ^ 0 per cent, contributions
in the Federation would remain at around
the absolute poverty level — and even the
10-25 per cent even if there were a 50 per cent
average net wage in Bosniac areas is already increase in real wages and 80 per cent of
on the absolute poverty line for a household employment were in the formal sector.37 In RS,
of three. the situation is again much worse: this scenario
• The proposed rate of 15 per cent is not far would leave contributions at around 35-70 per
below the current rate of 17.5 per cent in the cent of wages, which would clearly be at odds
Federation, which is described by the Bank as with the objective of reducing wage deductions.
'extraordinarily high' (World Bank, 1996b, p Only if unemployment were reduced to about 10
48), suggesting that there may be strong per cent and real wages doubled could
pressure to keep wage contributions well contributions be reduced below about 10 per
below this level in both Entities. This would cent of wages in RS.

61
The IMF, the World Bank and economic policy in Bosnia

Table 7: Pensions at alternative levels of unemployment


and real wages (US$ pm)

a. Federation

Unemployment (%)

60 50 40 25 10 0
0 31 38 47 58 69 76

wages:
25 38 48 58 71 85 95
real % 50 46 58 68 85 103 114
change
from 100 61 76 92 114 138 153
1996
150 76 95 114 143 172 191
200 92 114 138 172 206 229

b. Republika Srpska

Unemployment (%)

60 50 40 25 10 0
0 8 10 12 14 17 20

wages: 25 10 12 14 18 22 24
real % 50 12 14 17 22 26 29
change
from 100 15 20 23 29 35 39
1996 44 49
150 20 24 29 36
200 23 29 35 44 52 58

Notes: Author's estimates, assuming 1.1m work-force (one-third in RS), 0.42m pensioners (0.17m in RS), wage con-
tributions at 15 per cent, and administrative costs equal to 10 per cent of the total amount collected. The shaded
area represents pensions less than $ 1 per day. Base-line wages are estimated on the basis of the net monthly
wage figure given in Table 5, assuming current taxes and wage contributions of 50 per cent.

62
Social dimensions

Table 8: Wage contributions required for minimum unemployment


benefit coverage (% of wages)

a. Federation

Unemployment (%)

60 50 40 25 10 0
0 78 51 34 17 6 0

25 62 41 28 13 4 0
wages:
real % 50 51 34 23 11 3 0
change
from 100 39 26 17 98 3 0
1996 150 31 21 13 74 2 0
200 26 17 11 6 2 0

b. Republika Srpska

Unemployment (%)

60 50 40 25 10 0
0 230 153 102 51 17 0

wages: 25 183 122 81 41 13 0


real % 50 153 102 68 34 11 0
change
from 100 112 77 51 26 9 0
1996 150 92 61 41 20 7 0
200 77 51 34 17 6 0

Notes: Author's estimates, assuming unemployment benefit of $3 per day ($1 per person per day for a three-person
household). Other assumptions are as in Table 7.

63
The IMF, the World Bank and economic policy in Bosnia

£.3 Health and education the Federation, health services are currently
funded primarily through an insurance fund,
The health strategy for BH is based on a shift away financed through wage contributions at a rate of
from the top-heavy pre-war structure, and towards 12.5 per cent, which pays mainly for salaries. In
a system based more heavily on primary heath Bosniac areas and RS, similar insurance funds
care (PHC). Within the Federation, the intention were effectively merged with the general
is to shift towards a three-tier, insurance-based government finances during the war. In all
system, comparable to that for pensions. The first areas, the bulk of recurrent expenditure goes to
tier would be an Entity-wide package of uniform salary payments; but even so, salaries fell
basic services, and the second a supplementary drastically in real terms, and substantial arrears
package specified by each Canton, both financed were accumulated.
from payroll taxes and administered at the The programme of donor support to the
cantonal level. The third tier would be voluntary health sector, designed by the World Bank and
private health insurance. It remains unclear WHO, includes as one of its six objectives to
whether co-payments (ie additional payments made provide support for recurrent expenditure, to
at the point of service delivery) are envisaged for be phased out over three years. However, only
either or both of thefirsttwo tiers. Healdi financing $5m was firmly committed for this purpose in
arrangements within RS remain unclear. 1996 (equivalent to about $1.40 per capita),
The shift towards PHC is wholly appropriate, partly reflecting the 43 per cent shortfall in
and the insurance approach should be viable in overall commitments to the health sector (EU/
the Bosnian context, provided appropriate EBRD/World Bank, 1996, pp 132-3). This is a
arrangements are made for non-wage-earners. very small amount relative to the shortfall in
However, co-payments should be avoided for resources for recurrent spending on health; and
the foreseeable future, as they would risk if the planned reduction in support goes ahead
excluding a substantial proportion of the from this level, support will become increasingly
population from access to health services, while inadequate.
leaving them to pay part of the cost of services As well as the overall level of donor support,
for the better-off through wage contributions. its composition is also a problem. Despite the
Some caution is also needed with respect to arguments put forward by the World Bank for
private health insurance, as there is a risk of under- salary support, in practice aid has been mainly
paid health professionals being lured away from for essential drugs and other medical supplies,
the public sector by much higher incomes in while 'no significant support has been provided
private practice. In the long term, this problem for complementing health workers salaries'
should be eased to some extent by increasing (EU/EBRD/World Bank, 1996, pi34).
salary levels in the public sector, provided The government has tried to fill the gap
sufficient financing is available for recurrent (overall and for salaries) from general balance of
expenditure. The return of health professionals payments support; but this again increases
who have left as refugees would also help pressure elsewhere in the budget. While this has
considerably; but it remains far from clear that permitted some increase in salary levels, it is still
they will in fact return on a substantial scale. the case that 'most health workers are paid
The administration of health services at the insufficient salaries' (EU/EBRD/World Bank,
cantonal level could cause significant regional 1996, p 140). More generally, it is acknowledged
disparities in health sectors, with more limited that 'budgetary resources for the operating costs
services, fewer or lower-quality staff, more of health facilities will most likely remain
supply shortages, and possibly higher co- insufficient in 1997' (EU/EBRD/World Bank,
payments in poorer areas. The need for 'some 1996, pi37). However, this again appears to be
mechanism...to provide for cross-cantonal a serious under-statement of the extent of the
subsidies as required' is recognised by donors problem.
(EU/World Bank, 1996b, pi2). While this Yugoslavia's pre-war public expenditure on
inevitably raises the issue of inter-ethnic health was around $120 per person per year (in
resource transfers, such a mechanism would 1987, based on data from UNDP, 1992). A
seem to be essential. (See Dilemma 3.) return to this level of funding through pay-roll
Financial constraints, particularly on recur- taxes would give rise to very high rates of wage
rent expenditure, are a critical factor in the contributions: 3 0 ^ 0 per cent in the Federation
health sector in both Entities. In Croat areas of and 100-120 per cent in RS at present, declining

64
Social dimensions

only to 15-20 per cent and 40-50 per cent in These figures are probably somewhat
2000. In the long term, assuming real wages exaggerated. Costs should be reduced to some
100-200 per cent above current levels and 0-10 extent by the proposed shift towards primary
per cent unemployment,the rate would become health care; and (in the short and medium term
sustainable in the Federation, at 5-10 per cent. only) by low salary levels. Nonetheless, even
In RS, however, the rate would remain in the allowing for a halving of per capita health
order of 15-25 per cent, which is clearly unsus- spending from the pre-war Yugoslav level,
tainable (Table 9). together with the costs of minimum pensions

Table 9: Wage contributions required to restore pre-war per capita health


expenditure (% of wages)

a. Federation

Unemployment (%)

60 50 40 25 10 0
0 40 32 27 22 18 16
25 32 26 22 17 14 13
wages:
real % 50 27 22 18 14 12 11
change
from 100 20 16 13 11 9 8
1996 150 16 13 11 9 7 6
200 13 11 9 7 6 5

b. Republika Srpska

Unemployment (%)

60 50 40 25 10 0
0 119 96 80 64 53 48

wages: 25 96 76 64 51 42 38
real % 50 80 64 53 42 35 32
change
from 100 60 48 40 32 27 24
1996 150 48 38 32 25 21 19
200 40 32 27 21 18 16

Notes: Author's estimates, based on 1987 health expenditure of $120 per person per year, Other assumptions are
as in Table 7 (excluding administrative expenditure, which is included in the $120 figure).

65
The IMF, the World Bank and economic policy in Bosnia

and unemployment benefits, this would leave In the education sector, financial support has
tax and contribution rates on wages at very high been concentrated on school reconstruction
levels, in marked contrast with the objective of (more than 80 per cent of funding), with
reducing the rates of wage taxes and smaller-scale support for institution-building,
contributions. (See Table 10.) teacher training, educational materials, and
Despite the very conservative assumptions support for students whose education was
used in Table 10 (including the absence of any disrupted by the war, traumatised children, and
form of taxation on wages for any other purpose), children with special needs. The future direc-
the short-term levels of wage contributions are tion of education policy remains unclear, partly
clearly unrealistic in both Entities — around 100 as a result of uncertainty about the roles of
per cent of gross wages in the Federation, and 3- different levels of government and limited
400 per cent in RS. In the Federation, a moder- capacity for policy-making at the cantonal level.
ate reduction from current levels might be As in the health sector, teachers salaries are a
possible in the medium term (ie by about 2000), serious problem; and this is 'a fundamental
a sustainable level of 10-20 per cent being reached threat to education in the future' (EU/EBRD/
only in the long term (ie when unemployment is World Bank, 1996, pi22). This is again partly
reduced to 10 per cent or less and average real due to uncertainty about government roles,
wages at least doubled from their current levels. largely as a result of inadequate administrative
In RS, the situation remains clearly impossible capacity (and in most cases financial resources)
until well after 2000, and even the very opti- to plan and manage education effectively at the
mistic assumptions of the long-term scenario cantonal level. However, in view of the import-
leave wage contributions for these three purposes ance attached to this issue, it is far from clear that
alone at 31-54 per cent, suggesting that a this is an adequate reason for the complete
significant reduction is likely to be impossible. absence of donor support to teachers' salaries.

Table 10: Wage contributions required for minimum pensions,


unemployment benefits and health expenditure (%)

Pensions Unemployment Health Total


Benefit

Federation: 1996: 15 51-78 16-20 82-113

2000: 11-13 11-23 7-9 29-45

long-term: 4-7 0-3 5-9 9-19

Rep Srpska: 1996: 45-56 153-230 96-119 294-405

2000: 20-27 34-68 42-53 96-148

long-term: 15 0-9 16-27 31-54

Notes: Author's estimates, based on Tables 7-9, assuming unemployment of 50-60 per cent in the short-term, 25-
40 per cent in the medium-term and 0-10 per cent in the long-term; and real wage increases of 0 per cent, 50 per
cent and 100-200 per cent respectively. Pension contributions are assumed to be 15 per cent, subject to a mini-
mum pension of $30 pm and a maximum of $60 pm. Unemployment benefit is set at $90 pm throughout. Annual
health expenditure is set at $60 pc, half of the 1987 Yugoslav level.

66
Social dimensions

There is a proposal to develop cost recovery The World Bank also appears to be
for higher education. There is likely to be less promoting the idea of private provision of
resistance to this in principle than in some education and health services at the primary
countries, as cost recovery was well established level. A recent Bank publication on Bosnia
prior to the war. However, there is a risk of noted that 'a combination of direct provision
skewing the benefits of higher education and regulated private provision has generally
towards those better able to pay; and in the been adopted' elsewhere, although it stops short
Bosnian context, this would almost certainly of recommending this as a policy (World Bank,
entail an ethnic bias towards the Croats and 1996b, p47). This option should be approached
better-off returnees, at least over the medium with great caution.
term, due to current income differentials. This
• In the health sector, there is a risk that
would tend to compound and entrench inter-
competition among private providers (with at
ethnic inequalities, and could also generate an
least partly public funding) could bid up the
ethnic imbalance among decision-makers over costs of health inputs — particularly the
time. It is also important to avoid any substantial salaries of health professionals — relative to a
reduction in overall attendance of higher educa- system based on a public sector monopoly or
tion, as the disproportionate number of grad- near-monopoly. This could substantially
uates and professionals among refugees is likely increase the cost of publicly-funded health
to leave an increasing shortfall in the supply of services in the longer term. There is also a
human capital as the economy recovers, unless danger of perverse effects on incentives,
there is a large-scale return (which is not reducing the quality of health services.
expected in the near future).
If the option of cost recovery for higher • The education sector is critically important to
education is to be pursued, it should at least be the development of the political environment
delayed until the bulk of the population can over the long term. If, as seems likely, educa-
afford to pay, and then be phased in gradually, tion were provided by organisations moti-
in line with ability to pay among the poorer vated by nationalist agendas, in the absence of
ethnic groups. Donors should fill most of the extremely rigorous monitoring and regula-
tion, this could seriously jeopardise progress
gap between the costs of higher education and
towards national reconciliation.
the available government resources and fee
revenues. They should also finance a It seems unlikely that there would be substantial
scholarship fund for those who are academically long-term benefits in the private provision of
able to continue with their education, but health services. In the case of education, this could
unable to bear the financial cost (including be positively dangerous from a political perspec-
forgone income) of doing so. Explicit ethnic tive. It would be better to avoid any movement
targeting should, however, be avoided. towards private provision in either case.

67
F. Conclusion

There are no easy options in Bosnia and payments support could be allocated between
Herzegovina. The situation is both very difficult Entities and Cantons on the basis of an
economically and extremely complex socially explicit formula measuring needs, for use in
and politically. Economic policy has to be form- support of recurrent expenditure.
ulated and implemented within three interlock-
ing sets of very tight constraints, political, social/ 4 Privatisation in the Federation raises a
ethnic, and economic, which seriously limit the number of issues relating to the role of
available options. Where alternative approaches foreign investment, the pace of privatisation,
to those currently proposed can be envisaged, and the proposed level of decentralisation. A
they often raise as many problems as they possible alternative approach is outlined,
resolve. which would be more gradual and more
In consequence, this paper has focused on closely related to the needs and circum-
exploring dilemmas, and the options they stances of individual enterprises, with a
suggest, rather than recommending specific greater role for foreign investment where
policy changes. Nine such dilemmas have been there is a substantial need for capital inputs
discussed: and/or imported technology.

1 Political conditionality is necessary to achieve 5 Free entry for foreign banks could help to
any progress against the background of improve the availability and reduce the cost
extreme political inertia in BH. However, it of financial services, but, in the current
raises the risk of skewing the allocation of aid, circumstances could give rise to a heavily
jeopardising economic recovery in RS, and foreign-dominated financial sector in the
compromising the donors' neutrality. A future. Delaying this process could reduce
carefully designed, graduated approach is this risk, but could also have a negative effect
suggested, avoiding conditionality on factors on economic recovery in the short term.
beyond the control of the authorities.
6 The trade policy envisaged for BH is based on
2 The currency board arrangement is probably a rapid reduction of tariffs to low, uniform
necessary in a highly decentralised political levels. A case could be made, on both political
system with a high level of political conflict and economic grounds, for delaying this
and inertia. However, it seriously constrains process, to allow a breathing space for the
economic policy, and raises theriskof a serious development of 'infant' and 'convalescent'
financial crisis after 1998-9. Two options are industries. This would also ease financial con-
proposed for further consideration: straints on government spending. However,
further consideration is needed of the
• a self-financing system of import tariffs and interaction of trade policy with the constraints
export subsidies, to achieve effective on exchange-rate policies imposed by the
exchange rate adjustment within the currency board system.
currency board system; and
• a temporary support facility for the 7 Labour market deregulation may be helpful
Central Bank, to be activated in the event to employment creation in the short term, but
of a crisis beyond the authorities' control. a gradual and flexible restoration of employ-
3 Regional inequality is a particular problem ment standards (for example, to bring
because of the political obstacles to inter- standards into line with the EU's Social
regional resource transfers. It is suggested Chapter) may be both feasible and desirable
that part of the anticipated balance-of- over the long term.

68
Conclusion

8 Rapid movement towards full cost recovery Further consideration needs to be given to the
for public services and utilities fails to take establishment of a sustainable system of
account of public goods, and could give rise financing for social expenditures over the long
both to a substantial social impact and an term.
increase in regional disparities. This suggests Clearly, the economic, social, and political
the need for a more selective and gradual problems of BH are intractable in the extreme;
approach, and for social-pricing mechan- and they are compounded by the critical
isms. However, this would take resources tensions which remain among the various ethnic
away from other uses and entail potentially groups, and particularly their political leaders.
problematic inter-ethnic resource transfers. The current institutional arrangements have
prevented these tensions from turning into
9 Employment creation is recognised by donors renewed physical violence; but they have
as a fundamental objective, essential to social neither resolved the tensions nor allowed them
and political stability. However, the to be set aside so that normal political processes
reconstruction process to date has had a and policy-making can be resumed.
limited impact. There might be a case for a Any progress towards resolving the problems
limited and selective shift of external resources will require a great deal of effort and
towards job-creation through public works pragmatism on all sides. This includes the
projects, particularly if their cost could be donors (and NGO advocates) as well as the
reduced from the current very high level. authorities and political agents within BH itself.
More generally, the implications for At present, the movement of the authorities (or
employment should be a key factor taken into at least the Serb and Croat authorities) towards
account in assessing the alternative moderation and pragmatism remains limited.
approaches to privatisation and trade policy There also seems to be a question-mark over the
outlined in Dilemmas 4 and 6. pragmatism of the donors, in that the policies
they are advocating for BH closely resemble the
A further serious problem arises from the cost free-market model which conforms to their
of minimum pensions, unemployment benefits, ideological position. These policies are not
and health services. These cannot be adequately necessarily wrong, but nor should it be
financed from wage contributions in the short automatically assumed that they are necessarily
term, or, in RS, in the medium term. Even with right.
a reduction of unemployment to 10 per cent and The need for pragmatism extends well
a doubling of real wage levels, the wage beyond the realm of economic policy, in partic-
contributions required to sustain pensions and ular to the long-term political future of BH.
unemployment benefits on the absolute poverty There is a tendency on the part of the major
line and half the pre-war level of health donors — and international NGOs — to assume
expenditure would be more than 50 per cent in that the long-term solution to the Bosnian
RS. This is clearly at odds with the objective of problem is a reunification of the country as a
reducing wage-based social contributions and single multi-ethnic state. This is neither valid as
taxes. an assumption, nor defensible as an objective in
Greater donor support for safety-nets and itself. If the ultimate objective is a peaceful and
recurrent expenditure on health and education prosperous future for the people of BH, the
is essential in the short term, extending well country's political future must be subject to
beyond 2000 in RS. Such support has been critical and objective evaluation.
totally inadequate so far, and will become This raises the most fundamental and
progressively more so if the donors' plan to intractable dilemma of all: how many countries
phase it out over three years is implemented. should Bosnia-Herzegovina be?

69
The IMF, the World Bank and economic policy in Bosnia

Dilemma 10: Reintegration or partition?


The international community appears to be current boundary between RS and the
firmly committed to the notion of a single BH, Federation is, from this point of view,
with the ethnic integration of the pre-1991 essentially arbitrary. Partition would
period restored. There are a number of therefore be potentially disruptive in
possible reasons for this, some of which are economic terms.
better than others.
f. The complex pattern of the country's ethnic
a. Accepting partition would amount to an division would make separation
official endorsement of the results of ethnic complicated: RS is virtually divided into two
cleansing. This would not only be very parts, linked only by the Brcko corridor (and
difficult politically and raise major moral only subject to the results of arbitration38),
issues, but could also provide an incentive while the Federation is a complex patchwork
for ethnic cleansing elsewhere. of Croat and Muslim areas. Separation
would mean a choice between non-
b. More generally, the concept of ethnic parti- contiguous Croatian and Bosniac territories,
tion is at odds with Western liberal prefer- and at best a very tenuous link between
ences for coexistence and multiculturalism. Western RS and the rest of an enlarged
Serbia; or further ethnic relocation. The
c. Reunification and ethnic reintegration may former would entail considerable adminis-
be seen as providing a more acceptable trative complexity, and would require a high
(and expeditious) basis for the return of level of cooperation between die states (with
refugees. Germany, for example, in a serious risk of renewed conflict if it failed).
repatriating refugees, has accepted the The ethnic relocation option would almost
principle that people should not at present certainly be unacceptable internationally.
be returned to areas where they would be
members of the ethnic minority. A g. In the case of RS, unification with Serbia
successful transition to multi-ethnicity would raise particular problems, as the
would remove this constraint, and allow a western half of the Entity has closer
faster (and less politically embarrassing) economic ties with Croatia than with Serbia
repatriation. This might also be possible (or with the rest of Bosnia). Coupled with
with partition; but would require a very existing political differences between the
explicit acceptance of the results of ethnic two halves of RS and the tenuous
cleansing. It could also result in disputes geographical linkage between them, the
about the morality or legality of forcing prospect of partition could give rise to
people to return to ethnically-defined areas serious political divisions between the two
rather than areas of origin; and it would areas (and within the western area), which
leave no clearly-defined destination for a could undermine the stability of BH as a
substantial proportion of the refugee whole.
population (for example, people of mixed
parentage, mixed couples, and members of h. If control of the Croatian port of Ploce were
other ethnic groups). retained by the Croatian component of a
partitioned BH, the Muslim rump would
d. A single, unified Bosnia may be seen as become land-locked, weakening its
more economically viable than two or three strategic and economic position, and
separate states: even with the return of all leaving it critically dependent on Croatian
the refugees, the total population would be goodwill.
only 4.5m.
The practical issues (e-h) carry some
e. Bosnia's economy and infrastructure are weight, as does the concern about endorsing
based on the concept of BH as a single entity ethnic cleansing (a). Other aspects, however,
within the Yugoslav Federation; and the are less clear-cut. The refugee issue (c), in

70
Conclusion

Dilemma 10: Reintegration or partition? (continued)


particular, is primarily a matter of political nationalist propaganda, it can by no means be
convenience to donor governments. There is assumed that greater independence would
some basis for the 'small country' argument mean greater moderation.
(d). However, there are a number of A change in political leadership would
limitations to this view. require a shift in popular opinion; and as long
as the media remain nationalistic, any shift
• It has been argued (by The Economist, for towards moderation will at best be slow. The
example) that the process of globalisation current political dominance of nationalists will
makes smaller countries more viable than further impede this process, as they will have
has been the case historically. ample opportunity to find or create sources of
• If the alternative to reunification of BH conflict with other ethnic groups. The current
were the accretion of RS to Serbia and of nationalist authorities will remain in power
Herceg-Bosna to Croatia, the 'small for some years; and the extent of movement in
country' argument would apply only to the popular opinion required to remove them is
remaining Muslim area. considerable.
• Economic viability depends to a great extent As discussed earlier in this paper, a rapid
on political stability and the effectiveness of economic recovery cannot by any means be
public institutions; and it would at best take taken for granted; it could be reversed in
some time to re-establish these conditions three tofiveyears (ie roughly at the time of the
in a reunified BH. It is relevant to consider next elections), as international support for
whether this could be achieved more reconstruction winds down; and it is far from
quickly by partition. clear that employment generation and social
There is also some danger in seeking to safety nets will be adequate to provide a sub-
impose fashionable Western views of multi- stantial improvement in the standard of living
ethnicity and multiculturalism (b) in a very for much of the population. Improving living
different context where these concepts may be standards are in any case only a necessary, and
inappropriate. The fact that BH was a by no means a sufficient, condition for
successful multi-ethnic entity before 1991 reconciliation.
does not mean that it necessarily can be again. Ultimately, reunification will only be
The war, by its very nature, has had a successful if it is actively endorsed by an
profound effect on the relations between the overwhelming majority of all ethnic groups;
ethnic groups. A return to multi-ethnicity can and the factors considered above will be major
only be achieved to the extent that the impediments to such endorsement. It will at
resentments generated are resolved; but these best be some time — possibly measurable in
resentments are acute, and their resolution decades rather than years — before
will take a considerable time. reunification can be achieved.
There are some factors which could If reunification can be achieved at all, it will
contribute to this process — for example a require an immensely difficult balancing act.
more independent media, the replacement of On the one hand, the institutional arrange-
nationalists with moderates in the political ments adopted must be popularly acceptable
leadership, and a rapid and broadly-based in an environment of ethnic mistrust and
economic recovery. However, these develop- hostility; and be able to function effectively in
ments are not within the donors' control, and an environment of ethnic separation. At the
are by no means assured. same time, however, they must lead towards
Even if the media were more independent, reconciliation and moderation, rather than
they would almost certainly continue to be polarisation and nationalism; and foster
organised on an ethnic basis, in terms of both identification with former ethnic enemies in
editorial control and audience. Given the the same country rather than with members of
depth of the resentment, and the cumulative the same ethnic group in neighbouring
effects of nearly a decade of strident countries.

71
The IMF, the World Bank and economic policy in Bosnia

Dilemma 10: Reintegration or partition? (continued)

To be politically acceptable, the structure conditionally can enforce cooperation, in the


must allow the members of each ethnic group absence of genuine political will, cooperation
to remain more or less autonomous at the level is likely to occur only at theformallevel. This will
of effective power. At present, the variable make at best a limited contribution to the effec-
decentralisation enshrined in the Dayton tive operation of the institutional arrangements.
arrangements secures this. To function This implies a need for political condition-
effectively, however, the institutional arrange- ality to be closely targeted, carefully grad-
ments require a high level of cooperation uated, and designed on the basis of a clear
between the separately elected ethnic leader- understanding of the political dynamics. (See
ships. To ensure cooperation, the Dayton Dilemma 1.)
arrangements rely to a great extent on At the same time, the reliance on donor
sanctions against non-compliance — primarily conditionality to enforce cooperation may
the withholding offinancialsupport. jeopardise the donors' (perceived) neutrality,
There is a potential contradiction here. in that it requires them to associate themselves
Ethnic autonomy directly reinforces ethnic clearly and explicitly with the principle of
rather than national identity; and it entails an reunification — in other words, to align
almost complete separation of political themselves closely with the Muslim objective,
systems. Rather than fostering cooperation or in opposition to those of the Serb and Croat
reconciliation, it reinforces the tendency leaderships.
towards ethnic and political polarisation (as Thus it is by no means clear that the present
demonstrated by the September ] 996 election arrangements fulfil all of the conditions
results). This in turn weakens cooperation necessary to reintegration. Nonetheless, they
and thus impedes the operation of institutions may be the best that can be achieved, to the
(as amply demonstrated by the current extent that the problems noted above are
problems, both between RS and the largely inherent, and may well be insoluble. In
Federation and within the Federation itself). any event, reopening the process to redesign
This goes to the heart of the Bosnian the institutions is not a realistic option.
dilemma. Successful reintegration requires It is also unrealistic to expect the donors to
conditions which cannot realistically be expected adopt partition as an ultimate objective. While
in a segregated society with a high level of this would be an internally consistent position,
mutual distrust between ethnic groups (or at to the extent that donor support would almost
between their elected political leaders). In certainly result in partition, it would be in
other words, while it is possible to envisage a direct contradiction to the principles under-
reintegrated society which would be stable and lying the whole process of mediation, and
sustainable, it may well not be possible to would represent a clear, though implicit,
engineer the transition from the current situ- endorsement of ethnic cleansing. This is
ation to that ideal within a time-frame which neither likely nor desirable.
would be politically acceptable to the donors. Neither is neutrality a viable option, so long
Further problems may arise from attempts as donors are seeking to influence policy. The
to enforce cooperation within this framework. design of institutions and policies, and of the
The failure of cooperation requires the appli- whole process of reconstruction and rehabili-
cation of the available sanctions — that is, the tation, is critically dependent on the nature of
withdrawal of external support. However, by the future BH which they are to serve. They
their nature, these sanctions impede econ- need, to a great extent, to be designed on the
omic recovery in the recalcitrant areas; and basis either of reunification or of partition. In
this will exacerbate tensions. In other words, the current state of political inertia, opting out
the mechanism for achieving cooperation of the policy-making and institution-forming
may itself compound any failure of coopera- process would merely be a particularly messy
tion over the long term. However, even if way of bringing about partition.

72
Conclusion

Dilemma 10: Reintegration or partition? (continued)

This leaves the international community the form of a withdrawal of support. (If
with two viable alternatives: contingency planning were taking place,
however, it is unlikely that it would be overt,
• to design their interventions with the specific since openly planning for partition would risk
objective of pushing BH towards reunifi- legitimising and encouraging separatist
cation, and/or on the assumption that the tendencies, ultimately making partition more
country will ultimately be reunited; or likely.)
• to design policies in this way, while The impression created by this single-
planning explicitly for the possibility of minded pursuit of reunification is of a rather
ultimate partition. superficial and patronising view of the
divisions generated by the war, like parents
At present, donors appear to be following telling squabbling children to be friends
the former approach, with little outward sign again. This is not obviously helpful, and could
of contingency planning: to the extent that itself alienate nationalist leaderships and/or
there is a contingency plan, it appears to take their supporters.

73
Notes

1 This is a very brief and grossly over-simplified entering BH is estimated at 2-300,000, and
account of the war and the factors leading up there were about 300,000 Yugoslavs and
to it. Readers are referred to the substantial members of other ethnic groups pre-war, this
number of books on the subject, such as would imply that, at the very least, 25 per cent
Malcolm (1994), Bennett (1995) and of the current population of Bosniac areas
Crnobrnja(1996). would be Serbs and Croats; and, since the
2 There were some tensions before this, eg difference between the pre-war Croat popu-
Croat fears of Serb expansionism under King lation and the estimated current population of
Alexander in the 1930s, which was an Croat areas is only 300,000, at least half of
important factor motivating the Ustasas. these people would be self-identified Serbs.
According to Bennett, the notion of centuries These implications seem implausible.
of animosity between Serbs and Croats is a 5 Following the de-collectivisation of agricul-
'historical myth', based on media propaganda ture in 1953, private land holdings were
rather than actual history: 'until this century, limited to 10 ha.
most Serbs and Croats had virtually no contact 6 GSP (gross social product) is the nearest
with each other' (Bennett, 1995, p6). Bosnian equivalent to GDP in the national accounting
Muslims were at most collaborators with the system used in most socialist countries,
Serbs' actual enemies (the Turks), rather than including the former Yugoslavia.
there being any direct conflict between them. 7 This Section is based mainly on EIU (1996a,
The Second World War was not the beginning 1996b, 1997a, 1997b), supplemented by
of ethnic tensions in the region; but it various articles from The Economist.
represented (with the benefit of hindsight) the 8 The US, in particular, has linked the FRY's
point of no return. reentry to the IMF to progress on the extradi-
3 Thefiguresin this paragraph and the next are tion of war criminals and its policy towards
taken from Crnobrnja (1996), pp22-3. Kosovo. Progress on both has so far been
4 Fox and Wallich (1997, p3) give very different limited.
figures for population: 0.7m in RS and 2.9m in 9 'A Country with a Vision: Former Yugoslav
the Federation (2.5m in Bosniac and 0.4m in Republic of Macedonia Sets Regional Example',
Croat areas). However, these figures seem World Bank News, 15 February 1996, pp 3-4.
difficult to account for in terms of the pre-war 10 As the name suggests, the final beneficiary
ethnic distribution of the population. Accord- principle means that the debt is divided up
ing to Crnobrnja, pre-war census data (based according to which Republic, Entity, etc was
on self-identification) show 44 per cent of the the ultimate recipient of each individual loan.
population (1.9m people) to have been 11 The HIPC Initiative phases debt reduction
Muslims, 31.5 per cent (1.4m) Serbs, 17 per over a period of six years, each phase being
cent (0.7m) Croats, leaving 7.5 per cent (0.3m) conditional on a favourable track-record of
other ethnic groups and self-identified structural adjustment policies. The other
Yugoslavs. If the Muslim share of deaths and complication of the HIPC Initiative with
refugees is equivalent to their pre-war share of regard to BH is that, while its per capita
the population (which is probably a conserv- income is currently low enough to qualify, if
ative assumption), the Fox and Wallich figures economic recovery proceeds at the rate
would be correct only if there were 1.2m currently hoped for, it would exceed the
refugees from other Republics and members income threshold before the final stage was
of non-Muslim ethnic groups resident in reached.
Bosniac areas that is, if these groups constitute 12 An agreement-in-principle, in this context, is
roughly half the current population in these an agreement between the government of a
areas. Since the total number of refugees country and an appointed committee of its

74
Notes

commercial bank creditors. The agreement 21 This is illustrated by the dispute between
cannot be finalised until the terms agreed in Bosniacs and Croats in Mostar following the
principle have been accepted by creditors September 1996 elections: the EU's ability to
holding a specified percentage of the debt - secure a favourable outcome was seriously
typically about 95 per cent. compromised by the fact that virtually all its
13 Strictly speaking, this would almost certainly aid had already been disbursed, so that the
be illegal without a formal waiver by the banks Croats had nothing to lose by intransigence.
of the negative pledge clauses and sharing 22 This is proposed by the World Bank (1997b,
provisions in their loan contracts; and the FRY pp xxv, 37, 42), although they appear to
would once again have a sufficient share of the envisage subsidies from domestic resources
debts to block such a waiver. However, rather than aid receipts. The current status of
mechanisms are readily available to purchase this proposal is unclear.
debts informally; and some Latin American 23 EU/World Bank (1996b), p3.
governments are believed to have undertaken 24 The cost of the EPW programme per person-
such transactions during the 1980s. While the year of employment is estimated at $5,440.
FRY could make a legal challenge, it would be (SeeSection El.)
difficult to prove the offence, if it were well 25 The Fund for War Veterans, Invalids and
executed. Families of Deceased (20 per cent); the Fund
14 It should be noted that the following for the Protection of War Veterans (8 per
discussion is entirely speculative in nature. cent); the Retirement Fund (7 per cent); the
15 Net present value (NPV) is a measure of debt Education Fund (5 per cent); the Family
which takes account of its terms as well as its Planning Fund (5 per cent); the Population
absolute amount. For a loan at the market rate Resettlement Fund (5 per cent); and the
of interest, the NPV is the same as its face Restitution Fund (5 percent).
value, but it becomes progressively smaller as 26 Current and former soldiers are important
the interest rate declines. Increasing the holders of public sector liabilities, in the form
repayment period of a loan at a concessional of salary arrears.
interest rate also reduces its NPV, as the 27 A bond which is never repaid, but on which a
benefits of the lower interest rate are enjoyed constant stream of income is paid.
for longer. 28 This problem is much less serious in RS, where
16 This and the figures in the next two 69 per cent of inputs are imported, but 53 per
paragraphs are the author's estimates, based cent of output is exported.
on World Bank (1996b), Tables 5.2 and 5.3. 29 The SME funds were 'almost the only sources
Because of the rather unhelpful presentation of cash resources for enterprises in 1996'
of the Bank's projections, the figures given (EU/EBRD/World Bank, 1996, p83).
should be regarded as very approximate. 30 As discussed in Section B2, there is a risk that
17 A conspicuous exception is Brunei, which the World Bank's balance of payments projec-
pledged only $2m, but committed $ 18.7m, of tions will not be achieved, which could
which $ 16.7m had been disbursed by October seriously damage BH's external debt situation.
1996. Strengthening the balance of payments
18 World Bank financing was limited to $8m through changes in trade policies could help
mobility aids and training for die disabled and to avert this problem.
$2m for institutional and implementation support. 31 The likely ethnic locus of pressure for
19 Compared with current salary levels. This continued protection in unclear: the relative
estimate is based on World Bank estimates of strength of producers in the Croat areas
staff requirements (World Bank, 1996a, suggests that they would be best able to take
Annex II Appendix 2), assuming a 50-50 split advantage of the resulting opportunities in the
of staff between Bosniac and Croat areas, and a short term; but equally, if this approach were
900 per cent increase in salaries of those from successful in promoting local production,
Bosniac areas. producers in RS and Bosniac areas might be
20 As noted above, however, that this assessment more dependent on the maintenance of tariffs
is based on population figures very different for their continued viability.
from those used elsewhere in this paper (0.7m 32 According to EU/EBRD/World Bank (1996,
in RS and 2.9m in the Federation, as against p93), 'About 425,000 soldiers have been or are
1.2m and 2.3m respectively). See footnote 5. being demobilized.' If, say, 300,000 were

75
The IMF, the World Bank and economic policy in Bosnia

demobilised at a constant rate during the jobs at its peak (EU/EBRD/World Bank, 1996,
course of 1996, the average employment p94). Again assuming an average level of
figure for the year would need to be adjusted employment-creation for the year as a whole of
downwards by 150,000. This would leave a half this level, this implies an average cost per
further 125,000 jobs to be shed by further person-year in the order of $7,000.
demobilisation, so that employment would be 35 In Croat areas, no pension payments were
reduced by 275,000 (25 per cent of the labour- made in 1992-3; in Bosniac areas, payments
force) from its 1996 level overall. were six months in arrears in early 1996
33 Up to mid-November, 38 sub-projects had (World Bank, 1996b, p48).
been financed at a total cost of $2.96m; and 36 These figures are affected significantly if the
6,530 person-months of employment had population figures in Fox and Wallich (1997)
been created. This implies an average cost of are used. Assuming that the numbers of
$5,440 per person-year. The total value of the pensioners in World Bank (1996b) remain
project is $41.4m, spread over two years, valid, this would increase the pension levels in
implying the creation of an average of 3,800 Table 7 by about 10 per cent in the Federation,
jobs over that period, from a labour force of but reduce them by about 40 per cent in RS.
1.1m. At that time, three months after the 37 The Fox and Wallich (1997) population
project had come into operation, none of the estimates would increase the cost of a given
non-World Bank-managed funds had been level of wage contributions in the Federation
identified, leaving a financing gap of $31 m, or for a given level of unemployment benefit by
three-quarters of its total value (World Bank, about one-eighth, because they imply a
1996a, pi5). substantially greater share of population in the
34 Aid disbursements up to October 1996 were (lower-income) Bosniac areas. The RS figures
$720m (EU/World Bank, 1996a, Table 3), an are unaffected.
annual rate of $864m. It is estimated that the 38 The conclusion of the Brcko arbitration has
reconstruction programme created 250,000 been deferred until February 1998.

76
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