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By Frederic Sautet and Kyle McKenzie : BIO| 12 Mar 2020
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Policymakers working out the enigma of successful transitioning to a market economy have a possible model for success quietly rising in the Balkans. Montenegro—a part of the former Yugoslavia—separated from Serbia in May and it appears that the tiny nation's trajectory is solid.

Montenegro's peaceful revolution started well before the May referendum. The country began transitioning towards a Western-type economy in the 1990s by embracing political and economic reforms. The formal separation from Serbia freed it from rules that restricted Montenegro's ability to pursue more growth-oriented policies which means that, for the first time since 1918, Montenegrins control their own destiny.

The question is what path will the reborn state take? Will it continue to implement policy reforms and slowly establish itself as a prosperous small country? Or, will it follow the road that many other transitioning countries followed and stifle the reforms?

Reforms so far have focused on building an open economy, fostering an environment favorable to business enterprise, and attracting foreign investors. For example, before joining the union with Serbia, Montenegro significantly reduced all tariff rates on imports and exports. Joining the union required that Montenegro harmonize its tariff rates with Serbia, but Montenegro refused to implement the policy for all products and went on to submit a separate claim for accession to the World Trade Organization.

The country's effort to develop capital markets has been one of the most successful of any transition economy and increased foreign direct investment. The Law on Privatization, adopted in 1999, set up very clear legal foundations for the process that led to the success of the capital markets. The development of these markets was integral in the learning of the workings of a free market economy for the former socialist country. As a consequence, Montenegro now leads the region in trading volume and stock ownership is on the rise.

Montenegro's auspicious start doesn't mean that decisions in the future won't be difficult to make. There are several unfinished reforms that play a large part in holding back the economic development in Montenegro.

For instance, although Montenegro has made strides to obtain a budget surplus, it continues to struggle with a relatively large amount of public spending—44.6 percent of GDP by the end of 2006. The labor market in Montenegro also continues to be highly regulated. The informal economy is still very large. There still exists a large hurdle to be overcome in the steps and duration it takes to start a business. Finally, there are large cultural remnants left over from Montenegro's socialist past that must evolve if the fresh start of becoming a new country is to lend itself to addressing head on all of these problems.

Montenegro's compass seems to be working correctly, but experiences in other countries can be instructive for policymakers facing large decisions that Montenegro faces now and in the future.

Estonia, for example, had around 95 percent of its workforce employed in state-owned enterprises in 1990. In 1992 they passed the Privatization and Employment Contracts Act which lightened the burden on employers. Unemployment rose after the passing of this act as workers transitioned out of state-owned employment into private firm employment. However, since 2000 the unemployment rate has been steadily declining.

Clearly, labor market reforms in post-socialist countries lead to unemployment in the short to medium-term, but Montenegro should follow Estonia's example and liberalize its labor markets to encourage the creation of real jobs.

With the creation of a new country, large constitutional questions remain. The largest that seems to be looming right now is the question of whether or not to join the European Union. Many view this question as a no-brainer, a panacea for all of a country's woes. However, stepping back and getting some perspective could lend itself to rethinking the easy answer.

Many of the countries in the EU, including some of the founding countries of France, Germany, and Italy, are not in great shape. Budget deficits are ever present; public debt is growing; welfare systems are in crisis; pension systems are on the verge of bankruptcy; actual unemployment is high; and real growth rates are small on average. In recent times, this has shown in the growth rates.

In Montenegro, the growth of GDP in real terms from 2002 to 2005 reached almost 15 percent (admitting that the country may have more room to grow fast than many EU economies), when the GDP growth rate for many of the founding EU countries has hovered around two to four percent.

Another issue about joining the EU stems from the fact that Montenegro is an extremely small country with a population of just over 600,000. Professor Vaselin Vukotic has even proposed constitutional changes around the idea of a "micro-state." As he puts it, the "key idea of the microstate is to build, instead of a paternal and all over present but weak state as we have now, a minimal but efficient state."

However, this idea would seem to conflict with the idea of joining the EU which, instead of being a large trade zone, has morphed into a supra-national government that legislates endlessly. What would happen if a small state like Montenegro were to implement 120,000 pages of EU legislation?

Montenegro's future is unquestionably hopeful; even the tourism industry has been booming lately and the most recent Bond film's glamourous representation of the country's resorts is sending the right message about the beauty of the country. Initial reforms went in the right direction; especially encouraging as they were carried out as Montenegro was still part its union with Serbia. Recent reforms have aided in the fast growth that the country is currently undergoing.

However, the country stands at a crossroads and there are many more critical choices ahead that will be crucial to the long-term success of Montenegro. They no longer have Serbia to hold them back—or blame.

Today, policymakers can, and must, take responsibility for the outcomes of the choices they make—no more scapegoats. It can turn its back on a bright future and join the queue of transitioning countries that so far have failed to make it out of their socialist past. It can also continue to make policy choices inspired by what happened in other places, such as Estonia, and become the first Mediterranean tiger.

Frederic Sautet is a senior research fellow and Kyle McKenzie is a research fellow at the Mercatus Center at George Mason University. They co-authored "Montenegro: The Challenges of a Newborn State," (Available here), with Maja Drakic of the University of Montenegro and the Montenegrin think-tank ISSP

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