Potential for growth in the Western Balkans’ machinery sector
• Machines • Technical Articles • South-East European INDUSTRIAL Мarket - issue 4/2020 • 05.11.2020
For all of the Western Balkan countries, the EU is the leading trade partner accounting for almost 70% of the region’s total trade, while the region’s share of overall EU trade is only 1,4%. Trade with the region has grown by almost 130% over the past 10 years, with total trade between the EU and the Western Balkans reaching EUR 55 billion in 2019.
Since the launch of the Stabilisation and Association Process, the EU has progressively concluded bilateral FTAs – referred to as “Stabilisation and Association Agreements” (SAAs) with each of the Western Balkan partners: Albania (2009), North Macedonia (2004), Montenegro (2010), Serbia (2013), Bosnia and Herzegovina (2015) and Kosovo (2016). The SAAs are tools which provide for the economic development and political stabilisation of the countries in the region, and for the creation of a close, long-term association between the EU and the Western Balkans. In effect, the SAAs constitute the legal instrument for alignment to the EU acquis and progressive integration into the EU market.
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Albania (2000), North Macedonia (2003) and Montenegro (2011) are already members of the World Trade Organization (WTO). The WTO accession negotiations with Serbia and Bosnia and Herzegovina are still ongoing. The Central European Free Trade Agreement (CEFTA) is a single Free Trade Agreement (FTA) linking all the Western Balkans.
Overview of the machinery sector in the Western Balkans
The machinery sector in Western Balkans is very broad and complex and includes a wide variety of products such as intermediate products used in other sectors, including engines or transmission shafts, and final consumption products, such as harvesting machinery or washing machines. Products within the machinery sector can also be characterised as general purpose products, i.e. used in wide range of industries, or special purpose products, i.e. machinery to be used exclusively in a specific industry or a small cluster of specific industries. Considering the sector’s breadth, there are therefore large variations among different sub-sectors when it comes to the requirements and factors that drive the sector’s growth. The machinery sector’s value chain in the Western Balkans is highly fragmented, depending on the different actors at the downstream and upstream levels of the value chain.
The variations in end customer demand by sector (or by final consumer at the upstream level of the value chain), effectiveness of sales and distribution channels, and availability and prices of raw materials at the downstream level of the value chain all play an important role in the machinery sector, which is dominated by micro, small and medium-sized enterprises (MSMEs).
Key growth factors
The relevant literature identifies several key factors for the growth and competitiveness of the machinery sector. The first one is the availability of financial capital, which affects the operational ability of existing enterprises and their decisions to upgrade production, while also influencing the entry of new enterprises into the sector. The uptake of information technology (IT) and the availability of digital skills have the potential to boost productivity and facilitate the integration of domestic enterprises into global value chains. An MSME-supportive environment can help MSMEs to enhance their competitiveness by improving their performance across a wide range of activities. Another key factor is targeted and proactive investment promotion and facilitation that can foster domestic and foreign investment.
According to the report Transformation Potential for Growth in the Western Balkans, published under the responsibility of the OECD in 2019, the machinery sector contributes little value added to gross domestic product (GDP) in the Western Balkan economies. The regional average was estimated to 1,2% of GDP in 2016, while that of Central and Eastern European (CEE) economies was 3,1%. Additionally, the relative weight of the machinery sector in the Western Balkans decreased during 2012 – 2016, while increasing in CEE in the same period (-0,2% and 0,7%, respectively). Among the Western Balkan economies, Serbia was the exception with a growth rate of value added of 2,2% and a contribution of 1,7% of value added to GDP, which is comparable to some CEE economies.
In terms of product complexity in the machinery sector, the Product Complexity Index (PCI) of the Western Balkan economies is aligned with the average for the entire sector (2,52). More precisely, Albania (2,43), Kosovo (2,48) and Montenegro (2,48) have a slightly lower than average PCI for their machinery exports, whereas Bosnia and Herzegovina (2,53), North Macedonia (2,56) and Serbia (2,53) are slightly above this figure.
The economies for which enterprise data are available and which have the strongest machinery sectors in the region are Serbia, North Macedonia and Bosnia and Herzegovina.
The total number of active enterprises in the machinery sector in these countries was about 1,1 thousand in 2015 – 2016. Among these three economies, Serbia hosts almost three-quarters of machinery sector enterprises while North Macedonia and Bosnia and Herzegovina host 13,3% and 11,7%, respectively. As in many other economies, the machinery sector in the Western Balkan economies is driven by MSMEs, accounting for 98,9% in Serbia, 99,3% in North Macedonia and 97,7% in Bosnia and Herzegovina.
Among the MSMEs in the machinery sector in these three economies, the majority are micro enterprises with less than 10 employees (on average, 72,6%).
According to data by the Statistical Office of the Republic of Serbia, 2017 and Eurostat, in 2019 the importance of the machinery sector for the three countries – Albania, Kosovo and Montenegro – measured in gross value added and value of exports, is relatively small. In Albania the gross value added amounts to USD 7 million, which is 0,1% of total GDP. Exports reach USD 53 million, which is 2,5% of the total amount of exports. Kosovo’s value of exports is USD 9 million or 2,5% of total amount. Montenegro’s gross value added is USD 16 million or 0,4% of total GDP.
Trade performance of the machinery sector
During 2012 – 2016, machinery sector exports in the Western Balkans grew, on average, more than the average of those in CEE (5% versus 0,6%, respectively), which can be expected given the much higher base of machinery sector exports in CEE economies. Export growth was particularly impressive in Montenegro and Serbia (8,7% and 6,1%, respectively). All Western Balkan economies export relatively more medium-high-technology machinery products than high-technology products.
Aside from Kosovo and Montenegro, where machinery products are largely exported to other Western Balkan economies, the remaining four Western Balkan economies export machinery products primarily to the EU. This suggests that the Western Balkan economies are taking advantage of the close proximity of EU markets. For example, Albania exports about 74% of its machinery to Italy, and the top three performers in the machinery sector (Bosnia and Herzegovina, North Macedonia and Serbia) export predominantly to Germany.
In terms of export value for the Western Balkan economies, the most relevant machinery products for which export values have risen constantly between 2012 and 2016 include electric motors (Albania and Serbia), medical instruments (Bosnia and Herzegovina), calculators (Kosovo), broadcasting accessories (Montenegro). Specific promising products with rising export values that would contribute to raising economic complexity in the region are: electrical power accessories (Albania and Serbia), heating and lifting machinery (Bosnia and Herzegovina and North Macedonia), and washing and bottling machines (Kosovo and Montenegro).
Key factors of machinery sector competitiveness
The machinery sector in the Western Balkans is a capital- and knowledge-intensive sector, which is largely driven by MSMEs. The sector is influenced by the demands of final consumers and the industries using its products at the downstream level of the value chain as well as the availability of materials and resources at the upstream level of the value chain – all of which play an important role in its development.
To ensure the necessary financial capital for the machinery sector, measures need to be taken to improve access to finance enterprises – especially MSMEs – in their efforts to upgrade production processes, innovate and better integrate into global value chains.
Given the high degree of investment required in the machinery sector, as well as the large number of MSMEs with limited funds available to invest in upgrading and innovation operating in the sector, financial constraints can represent a significant barrier to the sector’s growth.
As a result of the financial crisis, credit to the private sector contracted rapidly in the Western Balkans from 2008 onwards. The figure has improved during 2014 – 2018, the average share of non-performing loans being about 7,9%. However, despite this improvement, the share remains higher than before the crisis as per data from OECD.
The current financing gap in the Western Balkan economies results from constraints on both the supply and demand sides. On the supply side, there is a lack of available credit, which is coupled with punitive interest rates and unattractive market opportunities. On the demand side, the Western Balkan economies are suffering from a lack of entrepreneurial training, ineffective business strategies and inadequate private assets, which hamper business growth.
Production and operational processes in the machinery sector are undergoing radical changes as a result of the increased use of IT. It is estimated that IT and digitalisation will have an important impact on factory processes in the machinery sector. For example, automation and electrification linked to intelligent control systems (e.g. centralised mechanization processes) are becoming increasingly more important for various production segments according to data by GTAI, 2019.
MSMEs constitute an important part of the machinery sector in the Western Balkans and therefore play a vital role in its development. However, they often face a number of challenges, which prevent them from effectively scaling up their productivity and developing new products. These challenges can include weak management and technical skills and the inability to tap into new markets, as well as challenges related to the application of new technologies according to data from OECD.
Despite the potential benefits of business support services (BSS) for MSMEs and the efforts of governments to provide them, the uptake of BSS by MSMEs is very slow across many economies. This relates to many factors, among them being lack of information on BSS availability and their benefits. According to an OECD assessment in 2017, MSMEs in North Macedonia, Bosnia and Herzegovina, Montenegro, Serbia and Turkey provided publicly co-funded support in the form of general information (e.g. on the relevant legislation for starting a business or on how to develop a business plan). The four economies also provided more pro-active support, including training and/or mentoring and consulting.
There is great diversity among the Western Balkans in MSMEs’ uptake of publicly (co-)funded business support service, with two economies – Serbia and Turkey – having much higher figures than the others. Whereas 18,8% of MSMEs in Serbia and 23,1% of MSMEs in Turkey used a publicly (co-)funded BSS in 2017, only 3,0% of MSMEs did so in the other five Western Balkan economies on average. Bosnia and Herzegovina, North Macedonia and Serbia are the economies with the strongest performing machinery sectors among the six Western Balkan economies.
All six Western Balkan economies have created investment promotion agencies (IPAs) with a mandate to promote and facilitate inward foreign direct investments (FDI).
However, the IPAs vary in their objectives in terms of attracting investment and in the adequacy of the resources available to achieve these objectives. IPAs in the Western Balkan region, in general, undertake the identification of economic sectors that are potentially relevant for FDI attraction. They generally assist only those companies that have already expressed interest in investing. Nevertheless, North Macedonia and Serbia have a more proactive approach to FDI and use coordinated targeting strategies to reach potential investors. For example, the Directorate for Technological Industrial Development Zones bases its targeting activities on assigned geographical areas and leverages its sectoral knowledge through an effective client relationship management system.
Aftercare done by IPAs consists of a broad set of measures aimed at keeping existing investors satisfied, encouraging them to expand their activities or reinvest in new ones, and fostering linkages with domestic companies through regular dialogue with the private sector, whereby various business challenges and support measures can be addressed and brought to the attention of policy makers.
Measures to increase growth potential
Developing and implementing alternative financial tools could be done by factoring and leasing better suit low-risk enterprises and venturing capital or business angel networks as a preferable approach for high-risk firms. These countries need to strengthen the implementation of repossession rules under leasing mechanisms by speeding up administrative processes and by establishing commercial courts. Leasing activities sometimes show tax disadvantages such as value-added tax (VAT) incorporation in interest payments and double taxation standards. Independent leasing companies are also rare.
First attempts to develop early-stage financial infrastructure in the region are currently in process in Montenegro, North Macedonia and Serbia. Another way to further improve access to financial capital for machinery sector enterprises – especially MSMEs – is to extend supply-side support for risk capital investors together with co-investment schemes.
A vital prerequisite in order to increase the growth potential of Western Balkan countries is to support the uptake of information technology and the development of relevant digital skills to improve the sourcing, production and distribution processes of machinery sector enterprises and to better foster innovation. Improvement of average digitalisation by targeting the structural imbalances in the labour markets and digital exclusion is an essential step towards that goal. Policies addressing the prevention of and compensation for early school leavers through, for instance, the offer of additional opportunities for education and training outside the ordinary education environment should be designed.
By exploring models of co-operation with the private sector for the provision of computers and Internet connectivity in every school as well as making digital skills an integral part of continuing education will incentivize future development in the private sector. Uptake of business support services provided by the government and fostering government initiatives to stimulate private business support services is another factor playing a substantial role in unfolding the growth potential of Western Balkan countries.
Proactive investment promotion and facilitation will foster linkages with domestic suppliers and increase the outreach, effectiveness and scope of private BSS, addressing the needs of MSMEs in the machinery sector.
Increased investment in developing labour skills, strong research and development (R&D) and innovation system will be instrumental to the development of new products as well as the improvement of productivity and sustainability across the branches of the economic sector.
Keywords: Western Balkans, machine industry, machinery sector, MSME
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