Macedonia - Quo Vadis?

An Executive Summary of a Research Report Dated 7/8/99

Click HERE to read about the risks facing Macedonia in 2008

Issued by: Capital Markets Institute Ltd.
Sam Vaknin, Ph.D.)

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Macedonia is geographically positioned to become a trilateral bridge between Asia, Western Europe and Eastern Europe. It is the heart of the Balkans. With the proper promotion and dissemination of information, it could well become an important regional economic hub, as well. To achieve this, it has to adopt an export orientation, to encourage the formation of small businesses, to be friendly to FDI (foreign direct investment), to deregulate and open up to (domestic and foreign) competition in its infrastructure (telecoms, the banking system, etc.), to emphasize the protection of property rights and to start the process of privatization all over again - this time sincerely.

The World Economy in 1999

The Asian crisis is not over – it hasn't even started. It will erupt again, this time much more severely and mainly in Indonesia, China, Malaysia and Japan. This will create recession shock waves both in Europe and in the USA. The stock exchanges (headed by Wall Street) will be the first to adversely react. The IMF will be fast depleted of resources. The central banks around the world will not be able to implement tighter monetary policies and global inflation will be re-ignited. This inflation will be exacerbated by currency devaluations in South East Asia (China) and in Russia. The introduction of the Euro will further limit the flexibility of the counter-cyclical reactions of the economic authorities. This overall rigid response will force countries to adopt protectionist measures against the free flow of goods, services and, above all, capital.

The evaluation of the Macedonian economy in this paper, however, ignores this scenario. Should it transpire as we predict – the impact on Macedonia might be disastrous.

The Denar must be Devalued Gradually and Transparently

The trade deficit (at 400 million USD) equals 13% of the (admittedly, official) GDP and the current account deficit amounts to almost 8% of GDP. This is AFTER unilateral transfers of capital from donor countries and aid agencies and from immigrants. The reserves of the Central Bank cover 2-3 months of regular imports and, luckily, are insufficient to excite the big time speculators. Still, the currency is overvalued. In PPP-adjusted terms it should be converted at 37 to the DM (versus 31 now) and at c.70 to the USD (versus 56 now). If the Central Bank will not devalue the Denar at least to these levels shortly – market selling might force it to devalue it in a disorderly manner. The exchange rate stability is artificial, discourages exports and encourages imports. It also exerts deflationary forces in a deflation prone economy. The terms of trade of Macedonia have deteriorated by 14% these last few years. A devaluation forced by the market will be to much lower levels, in a very short period of time and it will adversely influence the inflation outlook in the country.


The Macedonian economy is totally illiquid and demonetized. High unemployment, a low money supply and the absence of money multipliers or accelerators (such as functioning credit providing institutions coupled with low credit ceilings and high interest rates imposed by the Central Bank) – have depressed any nascent inflation and, lately, led to demand deflation. To encourage growth, Macedonia must tolerate a 10-15% annual level of inflation (versus c. 5% now) and a minimum of 3-5% budget deficit (versus 1% now, if we ignore the Kosovo "blip"). There is no need to fear hyperinflation because of low demand. A devaluation will be mostly absorbed by importers and manufacturers. The government's fiscal and monetary policies are unduly restrictive and contractionary when they should be expansive.

If, however, the Central Bank will be forced by the market to devalue the Denar – the result will be profits for speculators and an inflation out of control. This will lead to stagflation – runaway inflation coupled with economic stagnation (the worst possible scenario for Macedonia).

The Macedonian Central Bank is forced by the IFIs (especially by the IMF) to maintain a DUAL TRACK policy, namely to observe BOTH an inflation target AND a stable exchange rate. This is a classic mistake, badly regretted in many countries now (examples: Brazil, Russia and Israel). By law, the Central Bank should ascertain the stability of the denar exchange rate. It is advisable to alter the law so that the bank observes an INFLATION TARGET, with a floor and a ceiling (an inflation band).

The Banking System

Is largely closed to outside influences. Foreign owners are either hesitant (Erste Bank, which withdrew from the bid for Stopanska Banka) or too institutional (EBRD, IFC) or marginal.

The banks are ossified, unable to cope with the newly emerging market economy. They reacted either by disregarding the quality of their portfolio while over-emphasizing mere size (Stopanska Banka) – or by being too conservative. Instead of developing effective methods to monitor and evaluate risks – they preferred to raise the commercial interest rates to outlandish levels. They offer no new services or products, lend only against real estate, favour cronies and cater to political wishes. The management in many of the banks in less professional than in the West. It is very likely that corruption is rampant due to favouritism and lack of transparency.

Only foreign ownership and CONTROL will alter this sorry state of things.

The Trade Deficit

The Macedonian economy is a "scavenger economy". At first, it benefited from the siege imposed on Serbia by the international community. Greek and other goods were shipped through Macedonia to Serbia. A lot of people got rich in the process. Now, Macedonia lives off its reputation as a "stable" country. The USA and other countries finance its trade deficit and other financial excesses – just to keep it as a buffer and a protection against instability in the region. This cannot last and is no substitute to long term policies. Macedonia must move from scavenging to being a "predator economy": eager to conquer new markets and prey on the competition. In the process, it might do well to get rid of magical thinking and wishful thinking. There is no "miracle or bingo" economics. It is all hard work.

A trade deficit is not inherently evil. If the money is spent on the importation of industrial raw materials and capital goods, the future profits will easily offset current deficits. But the Macedonian trade deficit goes to finance consumption goods and food. This is a malignant type of deficit, which will ultimately boomerang and hurt the local economy gravely.

What is needed is an orderly devaluation, the introduction of VAT and the imposition of some temporary import restrictions as well as the active encouragement of exports.

The Private Sector

The Macedonian people are very entrepreneurial. The level of taxation is tolerable. But there is no private sector to talk about. This is because there is no management culture, a lot of bureaucratic red tape, no capital markets, no business-oriented banking system, no real incentives or environment available to exporters and to small businesses and a crowding out of credit by failing, politically connected, or state owned businesses. The privatization process transferred state assets to the hands of an elite of managers at a discount on real values. The workers also received shares but could not dispose of them in any meaningful way. Even companies which could easily have been sold to foreign investors were privatized in this manner: Alkaloid, Pivara, Ohis, to mention but a few (Makpetrol, the PTT, Elektrostopanstvo can also be included in the lists of "easily sellable companies"). The companies thus privatized still rely too heavily on the state and engage in political lobbying rather than in production.

The Public Sector

Despite rumours to the contrary, the public sector is less corrupt than in comparable countries (according to Transparency International and to my own experience), well educated and capable. However, it is far too large and inefficient. This sector is subjected to economic laws, which were either copied from the West verbatim or phrased locally by legislators and "experts" who lack the necessary experience. It is not service oriented, poorly paid and considered a "dead end" careers.

Regional Devolution

The ethnic mix of Macedonia is explosive. This may be the reason why the central government was loath to transfer powers, authority and the money to back them to the regions. The regional economy is still very much centralized, planning is done from afar, the regions have no real taxing or spending autonomies (for instance: they cannot lobby abroad freely or raise funds in the capital markets because the land is not theirs to pledge, it belongs to the state).

But Macedonia is uniquely varied. It has an outstanding potential for tourism, transport and telecommunications. All of these can be developed regionally – rather than centrally. It is only the political will that is missing. In the world today – the central government is consciously transferring budgets and powers to the regions and the EU's motto is: "A Europe of regions". Macedonia has haltingly started to implement it – but the process is not fast enough.

Brain Drain

About 4% of the population left the country in the three years immediately following independence (1991-4). Another 2-3% left the country between 1994-8 (estimate). Many young people resent the fact the it is not merit that will determines their career path, but connections to the right people. Others face difficult personal choices: unable to buy apartments, they cannot form or raise families properly. Unemployment is a permanent feature and many young and unskilled or semi-skilled people are unemployed for years or reduced to menial jobs. This is a real threat to Macedonia's economic future and competitiveness in the global market. In a way, Macedonia is subsidizing the West with this export of gifted people. Unfortunately, there is not a lot that can be done to directly counter this phenomenon. It will disappear of itself (even be reversed, as happened in Israel) once the economy improves.


This is the cancer of the Macedonian economy: psychologically as much as financially, a burden on the state, a burden on the unemployed. Hitherto there was no serious treatment of this problem. In 1998, the government introduced a structure of tax incentives intended to subsidize new employment. Due to abuses, it was cancelled by the new government. But even that was absolutely insufficient and, in isolation, inefficient. The unemployment rate (already at c. 40% according to official figures) – is poised to GROW as the economy becomes more efficient, technology is introduced and real privatization takes root. This will be a social calamity. Experience in the world can guide the government: to increase labour mobility, to decrease the power of unions, to transfer unemployment benefits to the employer (in order to encourage him to employ the unemployed), to initiate public works (a Macedonian "New Deal" even at the cost of budget deficits), to encourage small businesses (microcredits, incubators, tax credits, preference in government procurement), to organize barter communities with voucher money, to encourage part time and flexible forms of employment. Israel, Holland, Britain and the USA are good examples.

Higher Education

The Macedonian workforce is more educated than its equivalents in Southeast Asia, for instance. The quality of higher education is impressive, with a few notable exceptions. Despite some corruption (university diplomas that are bought in cash rather than earned through toil, as the rumours go) – the overall picture is encouraging. But the stock of education capital (buildings, laboratories, libraries, computers) has dwindled to the extent that Macedonian higher education is risking becoming obsolete and irrelevant. Moreover, the universities and dedicated schools are churning out graduates with degrees in professions, which are irrelevant to the Macedonian economy. There is a huge mismatch between what Macedonia needs and what Macedonia gets from its higher education institutions. In this sense, these institutions abdicated their social responsibilities. They are no longer subject to planning of any sort: central or via the market forces (because there is no market in Macedonia as of yet).

The Judicial System and Property Rights

The courts are slow, hesitant and ineffective. Contradicting interpretations of economic laws by different judges are not a rarity. The system is under-funded, understaffed and bogged in a landscape of laws and regulations, which changes arbitrarily. There are no private or public alternatives to the clogged, backlogged nightmare. The laws are full of irrelevant "dead weed", are too complex and archaic or too open to interpretation. There are no reliable, publicly available central registrars of property and it, therefore, cannot fulfill the role of a collateral to the fullest extent. Intellectual property rights are not protected and Macedonia (with Bulgaria) is the piracy capital of Central Europe. All this – and the multi-annual tedious process of applying to the courts in the first place – erode the trust in the law enforcement system, in general and can bring about criminal alternatives to enforcement of contracts, for instance. There is no sign of a major reform in this field.

Taxation and the Black Economy

The "Black Economy" is called in Macedonia "The Grey Economy" because it is tolerated with a smile. Maybe luckily so: it comprises over 50% of the economy and is the less moribund and more vital part in it. Despite the fact that the taxes in Macedonia are very reasonable – collection is abysmal. Workers go unreported, income tax is paid only by employees in state or big firms, profit tax is eliminated by creative (false) accounting. Accountants in Macedonia are people who falsify books of firms so as to minimize the tax payable by them. VAT is being discussed for months on end but, for some reason, its implementation is always postponed. Smuggling is rampant. This situation cannot be cured by "strong arm" tactics because it amounts to a universal civil rebellion. A massive education campaign needs to be launched to demonstrate to the citizens the benefits that they stand to gain from paying their due taxes. Because the distrust between citizen and government (no matter of which party, government in general) runs so deep – it will not be an easy or short term task. Corruption in high places - an all pervasive phenomenon - won't help either.

Additional sections in the report:

The Orientation of Macedonia (Equidistance, EU, NATO, Balkan)

The Budget

Data and Statistics

The Media

Pensions Social and Welfare Benefits


Information and Knowledge – Infrastructure and Industries




Transportation and Telecommunications

Tourism and Catering

The Capital Markets

Foreign Direct Investments

Macedonia's Report Card - 10 Things that Could Go Wrong

January 2008

Like Blanche Dubois in "Streetcar Named Desire", Macedonians now prefer fantasy over harsh reality. They lash out at anyone who wishes to offset their euphoria with a long, hard look at hazards, real achievements, and true future prospects.

Under the tutelage of the Gruevski government, Macedonia made great strides in a surprisingly short period of time. The government should be lauded and complimented for its energy and initiative and its inordinate ability to transform Macedonia into a modern participant in globalization. The pace and extent of its accomplishments is incredible.

Yet, Macedonia faces 10 risks and the government is doing precious little to confront them:

1. Asset Bubbles

At a multiple of 37, the Macedonian Stock Exchange is a bubble, by any definition of the word.

The Macedonian Stock Exchange, as measured by its MBI-10 index, rose to a record high of close to 10,500 in mid-2007. It has since shed 30% of its gains. This correction, or, rather, rout has its roots is a series of converging factors.

Macedonia benefited from globalization. As its informal economy emerged from the shadows, capital controls were lifted, capital mobility increased, and foreign firms and investors entered the scene. The more the business climate improved, the better Macedonia's prospects appeared, the higher Macedonian stocks were valued by an euphoric public. Macedonia's professionals did nothing to restrain the hysteria or to ameliorate the casino mentality that pervaded the entire system. They benefited personally from the bubble.

The newfound optimism of Macedonia led to a repricing of risk and to heightened expectations of corporate profits, boosted by a more lenient tax regime and by decreasing interest rates. Equity risk premium plummeted until it vanished altogether and even became negative. The P/E multiple reached a stratospheric 50 before the recent correction. It is still pegged at an unsustainable 37.

Throughout this Bacchanalia, foreigners flocked into the Macedonian Stock Exchange, constituting 30-40% of the buy side. But they have begun to withdraw owing to big privatizations back home, troubles in their domestic financial systems, a more restrictive monetary policy in some countries, and the changing fortunes of the Macedonian marketplace.

The down trend in the Macedonian Stock Exchange is not a mere correction. It is a repricing of assets. It still has a long way to go. Even at 4300 - the next massive technical support - Macedonian shares are inanely overvalued.

Similarly, real estate prices are stratospheric, but this can be justified by the lack of reliable, scandal-free supply and the underdeveloped market for mortgages and real estate leasing.

Should one or both bubble burst, the adverse effects on consumption are likely to be noticeable.

2. Credit Bubble

In December 2007, holiday spending in Macedonia surged 100 million euros to 350 million euros. Most of the increase was financed with credits, as were the purchases of shares on the stock exchange, cars, and housing. High interest rates virtually guarantee that many of these loans will go bad. When they do, the government will be called upon to bail out the banking system. In all probability, it will.

3. Trade Deficit

Macedonia's trade deficit now equals 20% of its formal GDP (excluding the informal economy). It is unsustainable. Yet, the more vigorous the economy, the more the country's consumers and businessmen are likely to import. The culprits in engendering this imbalance are an overvalued currency, a hyper-liberalized trade regime, an antiquated and badly-managed industrial sector, and the profligacy of the population.

As long as unilateral transfers (such as remittances) cover the yawning gap in the current account deficit, Macedonia can survive with such irresponsible conduct. But, if the global economy turns sour, Macedonian Gastarbeiter will be forced to return home. This will likely precipitate a currency crisis.

4. Living Standards and Inflation

Inflation in Macedonia is severely under-reported by the government's Bureau of Statistics. Even so, living standards have dived with the rise in energy and food prices. The government doles out wage and pension increases but cannot compete with the global surge in the prices of commodities. Coupled with the aforementioned credit bubble, this is an ominous sign. Macedonia could end up having its own mini-version of the crisis in the USA: bankruptcies, credit crunch, and recession.

5. Foreign Direct Investment (FDI)

While Macedonia's image and perception as a business destination and the business climate have improved considerably under Gruevski's government, in reality, not much else has changed.

Consider the following numbers, pertaining to Macedonia:

Control of Corruption Indicator, published by the World Bank: 113 (2006) vs. 111 (2007)

Country Credit Rating, published by Institutional investor: 85 (2006) vs. 84 (2007)

Index of Economic Freedom, published by The Heritage Foundation and the Wall Street Journal: 75 (2006) vs. 71 (2007)

Quality of National Business Environment Ranking, issued by the World Economic Forum in its Global Competitiveness Report: 87 out of 121 countries.

Only the World Bank's Doing Business Ranking jumped from 96 (2006) to 75 (2007). Yet, even this indicator hides some unpalatable truths: Macedonia has deteriorated in certain respects. It is more difficult and cumbersome to hire workers, to register property, to obtain credit, to protect investor rights, and to enforce contracts. In any case, this indicator has more to do with public relations, expectations, and psychology, rather than with the hard facts on the ground.

And the hard facts are:

Macedonia is not ready to absorb and accommodate foreign investors and their capital. It still has a long way to go. This government has put the cart before the horses;

The youthful, populist, and inexperienced administration is overwhelmed and ill-equipped to deal with its obligations towards and promises to foreign investors. Decision-making bottlenecks (especially in the office of Vice-Premier Zoran Stavreski) conspire with red tape and blatant favoritism to render nightmarish both greenfield and brownfield ventures.

In a long-running arbitration, the country was slapped with multimillion dollar damages payable to the Greek investors in Okta. This did not deter the government from conflicting vocally and publicly with Macedonia's other large investor, the Austrian EVN, owner of the electricity utility;

To its credit, the government has reformed the tax system, introduced a flat tax, and reduced the tax rates, all laudable. But it is still illegal for foreigners to own land and real estate (as individuals) and all but impossible to trade in the local stock exchange. The government has only now resorted to tackling these archaic limitations;

The country is dysfunctional. No institution works properly: the cadastre, the courts, law enforcement agencies, the civil service are all in chaotic disarray. Even the banking system, despite a decade of FDI, is rudimentary. Infrastructure of all sorts is dismal, though improving. The government's anti-corruption drive is much lauded but highly politicized and one-sided, aimed as it is exclusively at the hapless politicians of the opposition. Macedonia's laws are not geared to welcome and assimilate foreign investment, foreigner businessmen, and foreign workers;

Macedonia lacks skilled manpower. The education deficit is pervasive. More than half the adult population has eight years of schooling or less. A multi-generational brain drain saps the country's vitality and prospects in the global information economy of the 21st century. Contrary to the government's claims in its "Invest in Macedonia" campaign, costs and taxes associated with wages are among the highest in the world.

The country suffers from other problems: a huge informal economy, skyrocketing consumer and enterprise indebtedness, ominous asset bubbles in both the stock exchange and the real estate market, a crippled middle class and crippling poverty and unemployment rates, an unmanageable and increasing trade deficit (c. 20% of GDP), and a whopping current account deficit offset only by remittances from Macedonian workers abroad. The global credit crunch constitutes a major threat to polities with such precarious finances.

Despite a slew of expensive PR and advertising campaigns; the appointments of two ministers and the formation of a special agency to deal with FDI; incessant trips abroad by every functionary, from the prime minister down; and innovative marketing initiatives - FDI figures for 2007, at c. 180 million USD (c. 3% of GDP), are a major disappointment. Moreover, a sizable part of Macedonia's FDI is in construction, retail, financial services, and trade, economic sectors with minimal contribution to future growth.

In comparison, FDI doubled in decrepit, post-bellum Serbia, to 4.5 billion USD in 2006. Croatia garnered 3.6 billion USD (2.7 billion euro) - twice the 2005 figure. Even strife-torn Bosnia-Herzegovina, under a EU peacekeeping mission, attracted 2.9 billion USD (2 billion euros). Bulgaria absorbed 6.5 billion USD. FDI amounted to 10% of Balkan GDP in 2006.

The conclusion is inescapable: Macedonia has failed in its bid to attract FDI. This is not the first time that Macedonian politicians and their downtrodden and destitute people prefer the fantasy of foreign saviors to the hard slog of painful and much-needed reforms at home. The current prime minister, Gruevski, served in the government of Ljubco Georgievski, whose nostrum and panacea to Macedonia's economic woes was dollops of money, supposed to be funneled via illusive Taiwanese investors. The person most identified with this policy, Vasil Tupurkovski, now faces criminal charges.

Gruevski can learn many lessons from the debacles wrought by his predecessors. It is not too late to get his priorities straight: reforms, education, domestic investment, and employment first, and only then an open invitation to foreigners to come and invest in Macedonia.

6. Geopolitical Risks

Geopolitical instability (in Kosovo) is exacerbated by the current Macedonian regime's jingoism, its overt and manipulative religiosity, and greenhorn fickleness. Within the last year, Macedonia has considerably retarded its chances to enter NATO and the European Union (EU), having clashed unnecessarily and spectacularly with Greece, Serbia, Bulgaria, and the Albanian minority at home.

7. Unemployment

The government's obsession with FDI as the solution for Macedonia's unemployment precluded a reasoned and coordinated effort to tackle unemployment head-on, especially by encouraging domestic investment. To this very day, the government has failed to come with a plan on how to fight unemployment in the short to medium term.

Consequently, unemployment has remained largely the same, at 35%. In certain sectors - such as mining and manufacturing - it even went up (by a whopping 8%, compared to 2005).

The government's concurrent attempts to fight the informal economy have the unfortunate effect of removing the only effective social safety net and source of income available to the unemployed.

8. Education

As is its habit in all other fields, the government is more concerned with grandiose schemes (computer for every child) than with the mundane and dreary reality of education in Macedonia: lack of infrastructure, no teaching cadre, no supportive social services (day care, for instance), or cultural ambience (the education of girls is still controversial in certain segments of Macedonian society).

The government is attempting to respond to the perceived needs of foreign investors by teaching skills to young and older alike. This is a step in the right direction. But, carried out in a vacuum of other policy measures, it is bound to backfire and end in a brain drain or in deep and lasting frustration.

9. Agriculture

Instead of acknowledging that Macedonia's agriculture is non-competitive for a variety of reasons, the government keeps pouring tens of millions of scarce euros into dying crops (tobacco, for instance). The solution is, of course, to scrap the entire Macedonian agriculture, retrain the farmers and embark on a bold plan to reorient the sector to off-season vegetables and flowers, high-value crops, organic produce, and bioengineering.

10. Over-taxation

When a government in a country as destitute as Macedonia wastes its money on the early repayment of debts to International Financial Institutions and ends up with a surplus in its central budget, its policies are wrong and constrictive. Rather than promote growth, the government is over-taxing. This leads to an inefficient allocation of resources. Rather than invest, the government increases wages in the public sector, augments pensions, and showers subsidies on dying sectors.

Paradoxically, such colossal waste is bound to end up in a demonetization and contraction of the economy as the private sector gives up its futile attempt to compete with the largesse of the government and as businesses are rendered rent-seekers.


The Gruevski government is business-friendly and growth-oriented. It is truly reformist. However, its policies of benign neglect and over-reliance on foreigners and their money as a nostrum and panacea threaten Macedonia with stagflation: inflation coupled with recession, increasing unemployment and negative growth.

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