Restarting Belgrade-Pristina talks could unlock funds for COVID recovery

Policy Pulse - George Anjaparidze - 24 June 2020

On 27 June 2020 the leaders from Belgrade and Pristina plan to meet in Washington, DC with the goal of restarting formal dialogue. The meeting has potential to be a turning point on the road to normalization of relations.

Political analysts have suggested that the timing looks promising. Both sides are at the start of their political mandates. Furthermore, key roadblocks that derailed previous efforts at dialogue have, at least in part, been addressed. Perhaps of most significance, the 100% tariffs imposed by Kosovo in November 2018 on imports from Serbia and Bosnia have been removed in April 2020. Earlier in June 2020, the new Kosovo leadership also removed the recently imposed non-tariff measures.

Both sides need international support to sustain a post-COVID recovery. Restarting Belgrade – Pristina talks on normalization can unlock additional funds to support the economic recovery following the COVID-19 shock.

Removing trade barriers is good for Kosovo and will ease recovery from COVID

The decisions taken earlier in the year to lift the mentioned tariffs and other non-tariff barriers are good for consumers and businesses in Kosovo. Reduced trade restrictions make it easier for Kosovo to bounce back from the COVID-19 shock as it becomes less costly to source inputs for the recovery.

As our previous analysis examined, these tariffs were harmful to Kosovo. A year ago, experts also warned that import taxes would lead to higher prices in Kosovo.

Estimated consumer prices inflation for 2019 shows that despite using the Euro, inflation in Kosovo was more than two times higher than the Eurozone average. The process used by the Kosovo Agency of Statistics (KAS) for estimating inflation could benefit from greater transparency, nevertheless, taking the published figures at face value indicates that inflation in Kosovo was 2.7% compared to the Eurozone average of 1.2%.

The higher rate of inflation captures only part of the impacts. A retrospective assessment of the tariff impacts would likely show that the tariffs led to a combination of higher prices, consumption of lower quality products and potentially lower profit margins in the distribution chain within Kosovo.

Restarting talks can help unlock new resources to accelerate post-COVID recovery

The IMF expects the outbreak of COVID-19 will severely curtain Kosovo’s economic performance through depressing tourism receipts, remittances, exports and FDI. Even at the beginning of April, IMF forecasted the economy to shrink by 5% in 2020, with external financing inflows cut by half. In 2018, personal remittances received were equal to 15.6% of GDP or €1.1 bn and expectation for 2020 point to a sharp contraction. Since these forecasts, the response to the epidemiological situation has led to an even weaker economic backdrop and implies an even worse outlook.

Across Serbia, COVID-19 is expected to have a significant adverse impact on the economy. The travel and tourism sector contributed to nearly 6% of GDP in 2019 and grew nearly two percentage points faster than the overall economy. In 2018, personal remittances received were equal to 8.8% of GDP or €3.9 bn. A major contraction in remittances and the travel and tourism sector combined with a challenging external environment pose serious difficulties to the post-COVID recovery.

Formally restarting the normalization discussions can help unlock additional international support for the recovery. Immediate opportunities for leveraging additional funds, beyond those already announced in the EU post-pandemic recovery plan, could come from EU instruments such as the Stabilization and Association Process (SAP) and investment initiatives targeting the Western Balkan region.

In the medium term, a particularly promising source of additional funds could come from the new EU methodology for enlargement, which promises to front load some of the benefits associated with the EU accession process. Historically, there was a big difference in the support provided through the instrument for pre-accession and the scale of funds that would be available upon EU membership through the EU cohesion program (see chart).

As illustrated in the chart, economic transfers from the EU under the instrument for pre-accession were significantly lower than the potential funds that would be available through the EU Cohesion program if Kosovo and Serbia were EU members. One of the aims of the new methodology for enlargement is to front load the benefits of EU membership and make them available throughout the accession process. While operational aspects of the new methodology are still being finalized, this new approach could serve as a major opportunity for accessing additional resources and lead to a scale-up in EU assistance during the accession process.

Combining economics and international support improves prospect of normalization

Imbedding economic issues as part of the dialogue on normalization has potential to improve the negotiation dynamics. A greater focus on the economic dimension could change the negotiation from a “slicing the pie” to a “growing the pie” dynamic.

Focusing on economic benefits in combination with targeted international support has potential to greatly improve the prospects of normalization.

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Kosovo: disappointing economic data to come?

Policy Pulse - 19 June 2019 - George Anjaparidze

Last week, Pristina hosted foreign dignitaries in celebration of 20 years since the departure of troops of former Serbian President Milocevic. It was also an occasion to showcase Kosovo’s progress in recent years across a number of critical areas. According to the World Bank 2019 Doing Business report, Kosovo was ranked as the 44th easiest place to do business, scoring higher than the Eastern European regional average. Life expectancy has risen from 69.2 in 2007 to 71.9 years in 2017. Despite these successes, there have also been misguided policy interventions. In particular, the decision in November 2018 to impose a 100% tariff on goods originating from Serbia is particularly damaging to Kosovo’s economy.

As a result of these tariffs, we forecast a significant reduction in the purchasing power of Kosovo consumers. Our impact analysis (How harmful are trade tariffs to Kosovo consumers?) estimates a reduction in purchasing power by 6.4% due to 33% higher import costs on goods impacted by tariffs (mid-range estimate). The chart above presents a sensitivity analysis on the range of cost impacts on goods covered by these tariffs. The chart also offers a breakdown on drivers behind the higher import costs. The analysis is top down in nature and assesses the expected future short-to-medium term impacts.

Domestic production in Kosovo is not well suited to offer effective substitutes for imports impacted by tariffs. Our analysis (Kosovo status quo has a high cost) highlights the lack of competitiveness of domestic production. This is consistent with the findings of a bottom-up assessment produced by the GAP Institute, which concludes that domestic production has not seen an increase in activity since the introduction of tariff measures.

The GAP institute uses Kosovo Customs commodity level and country of origin data to assess impacts. Perhaps the most surprising finding of the GAP Institute report is that 12% of exports from Serbia continue to be imported by Kosovo despite the 100% tariff. This points to the difficulty of finding effective import substitutes from other trading partners. While Veritas Global does not have access to this data, we find the GAP Institute assessment is a useful preliminary retroactive review of impacts. Once new data becomes available, we expect results will converge with our mid-range estimate of impacts.

Annex: Further details on sensitivity analysis on import costs from tariff measures

Logistics and weak transit system

On average, global logistics costs make up about 13% of the value of trade. Although, landlocked economies and those with less developed transit infrastructure have much higher costs, which can be as high as 25%. For purposes of being conservative, this assessment uses the global average of 13% as the basis of the estimate for logistics costs for imports into Kosovo. To estimate the impact of having to substitute imports for tariff impacted goods from more distant markets, the high-range estimate assumes a doubling in logistics cost for these goods. Meaning that an additional 13% in cost will be incurred. Sensitivity analysis is used to present a mid-range scenario whereby logistics cost will add 8.7% to import costs and low-range scenario of 6.5%. We consider this range to be appropriate, given the research findings from the World Bank on transport economics in landlocked countries.

Rent-seeking due to lower competition

The product markets for imported goods into Kosovo are best characterized as monopolistic competition. On average, the "monopolistic component" is likely to be significantly higher in Kosovo compared to economies that are well integrated into global trade. This is due to higher transaction costs, smaller market size and higher operational barriers. Therefore, in the short-to-medium term, the goods markets covered by tariffs will result in increase in rent-seeking behavior from existing supplies (non-tariff impacted suppliers). Evidence from rapid market exit (due to liquidation) in the US airline industry shows that following disorderly market exit an increase in fares of 12% was observed. The impact on fares was found to be persistent over time. For purposes of being conservative, this impact is estimated based on the share of the value of imports impacted by the tariffs rather than all products in impacted product markets. For the high-range estimate an additional 12% in cost is modelled. 8% and 6% is used for the mid and low-range estimates respectively.

Search and switching costs

In the context of the tariffs imposed by Kosovo, search costs are the costs incurred by importers in identifying an alternative market from which to source products impacted by the tariffs (for example staff time, travel expenses, relationship building etc.). Switching costs are the costs incurred by importers from changing suppliers (for example the need to make new currency conversions, open new accounts, draft new and close existing contracts etc.). It may not always be practical to distinguish between search and switching costs. Empirical research from Loughborough University highlights the need to look at search and switching costs together. Additional search and switching costs may also be incurred by consumers in the process of familiarizing themselves with substitute products.

Empirical evidence on search and switching costs suggest a significant range. For the high-range estimates this assessment uses findings on search and switching costs in the US auto insurance industry, where these costs are estimated at about 18%. Sensitivity analysis is used to present a mid-range estimate of 12% and low-range estimate of 9%. The unplanned and immediate effect with which the tariffs were introduced suggests that the range presented in the sensitivity analysis is appropriate. It is important to note that search and switching costs will dissipate over time as new trading relationships are established.

Delay and disruption

Delay and disruption costs will arise given the unplanned and immediate nature in which Kosovo introduced the tariffs. These are likely to arise as importers look for substitutes and establish new supply routes for products from other import markets. Empirical evidence on the impact of delay and disruption costs suggests a wide range. For example, an assessment of the Niigata-Chuetsu earthquake quantifies economic loss resulting from lower intra and interregional trade due to seismic transport network disruption in the range from 20-40%. Given the high variability and context specific factors, a conservative approach has been taken for estimating the short-run delay and disruption costs. For the high-range estimate an additional 6.5% in cost is modelled. 4.3% and 3.3% is used for the mid and low-range estimates respectively. It is important to note that delay and disruption costs are likely to be more immediate in nature and will dissipate over time.

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#kosovo #economics #tradetariffs #serbia #balkans

How harmful are trade tariffs to Kosovo consumers?

Policy Pulse - 12 June 2019 - George Anjaparidze

This week, Kosovo celebrated the 20th anniversary of the departure of troops of former Serbian President Milosevic. Despite two decades since the end of the worst of the violence and bloodshed, Kosovo remains troubled by its past. So much so that its past has clouded its judgement on economic policy today.

In November 2018, Kosovo announced 100% tariffs on all goods originating from Serbia. Based on 2017 data from the Kosovo Agency of Statistics, this tariff would impact €449.9 million or 14.8% of goods imported into Kosovo. As a result, this could decrease the purchasing power of Kosovars by €149.8 million or 6.4%. This is the equivalent of having Kosovars forego 23 days of consumption per year (See Chart).

What makes the tariffs particularly damaging for Kosovo is its poor integration into the global trading system. It is a landlocked territory with relatively weak logistics infrastructure and small domestic market. This means that, in the short-to-medium term, it will find it costly to substitute goods originating from Serbia with imports from other countries.

The World Bank estimates that landlocked territories have higher trade costs, which include higher costs of logistics, high degree of unpredictability in transportation time, widespread rent-seeking activities and weak transit systems. Furthermore, empirical research from Loughborough University points to the existence of high search and switching costs related to finding alternative suppliers, this will also contribute to driving up costs of substitutes. In addition, there may also be higher costs for the goods themselves. The combination of these factors will increase the cost of importing these goods, which, in the short-to-medium term, would lead to an increase in costs of these imports by about 33%.

There are several channels through which the tariffs will have an economic impact, two are highlighted below. First, if the bundle of goods imported are finished products that are consumed domestically in Kosovo, the impacts will be most directly felt by consumers. This is the scenario quantified in this assessment. Assuming these costs are passed through to consumers, they will face having to replace their consumption with higher cost substitutes, reduce consumption or switch to inferior substitutes. For purposes of this scenario analysis these impacts have been modeled to be of equivalent scale and on average equal to 33% of the value of goods imported (See Table 1). Second, if the bundle of goods imported are used as inputs in production processes, the impacts will be first felt by businesses unless they are able to pass through these costs to consumers or through the supply chain. The higher production costs may be even more damaging to the Kosovo economy. It will reduce competitiveness of businesses in Kosovo, thereby reducing activity and output, which will have a negative impact on employment and consumption.

The only economic rationale for this policy is if it is motivated by a desire to redistribute the gains of trade to a new set of entities (middlemen or producers) engaged in importing. Alternatively, the policy may be motivated by retaliation for blocking Kosovo membership in Interpol as well as emotive reasons, rooted in its troubled past. In either case, it is the consumers and businesses in Kosovo that pay the price for this ill-advised economic policy.

About Veritas Global: Our vision is to have a positive impact on the world through truthful advice informed by robust analysis. We are a premier provider of tailored solutions on climate change, international conflict economics and infrastructure.

#kosovo #economics #tradetariffs #serbia #balkans