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Tuesday, 15 November 2016

Brexit and its impact on the Western Balkans

Speaker: Peter Sanfey, European Bank for Reconstruction and Development
Chair: Jonathan Scheele. St Antony’s College, Oxford
Discussant: Adis Merdzanovic, St Antony’s College, Oxford

The impact of Brexit on the UK, Europe, and the world are discussed almost daily in the press and much uncertainty remains. Yet, often lacking from such discussions are its indirect impacts on third countries, such as those in the Western Balkans. In his talk, Peter Sanfey presented new research carried out by the European Bank for Reconstruction and Development on the impact of Brexit on Serbia, Montenegro, Bosnia, Albania, FYROM and Kosovo. His remarks were followed with a brief analysis of the political implications by Adis Merdzanovic from St Antony’s College.

The Western Balkans face an important convergence challenge. Currently, their income is around half of that of other Eastern European countries, and only a quarter of that of Western European countries. Yet, there have been some positive developments, with growth projected to average 3% in 2017, a stable macroeconomic situation, and declining non-performing loans. Over the medium term a set of factors enhance their attractiveness to investors: the prospect of EU membership, good relations with the IMF, a geographic location at a crucial point of China’s New Silk Road, the diverse range of economic activities, and favourable tax and labour costs.  
However, these benign conditions could be challenged by Brexit through a series of direct and indirect effects. Overall, the direct effects of a slowdown in Britain are likely to disrupt financial and investment flows, trade, and the movement of workers (as a source of remittances). However, the six Western Balkan countries are not very dependent on the UK – for example, only 1% of their exports are destined for Britain. 

Much more important are a set of indirect linkages through the repercussions of Brexit on Eurozone growth. Around 20-30% of trade for Serbia, Bosnia, and FYROM takes place with the EU. Additionally, remittances from mostly Eurozone countries (such as Greece, Italy, Germany, and others), are a key source of finance, averaging around 10% of GDP for some countries. Therefore, potential problems faced by the Eurozone as a result of Brexit will reverberate strongly in the region. 

However, Dr. Sanfey was particularly worried about two other indirect linkages related to the local reform process and the future of financial transfers. Previous EBRD research has highlighted a link between reforms and growth in transition countries, so a slowdown in reforms is expected to have a negative impact on GDP. Yet, the biggest reform spur typically happens in the 3 years prior to EU accession when countries see the finishing line. If Brexit leads to less interest in enlargement, this will lead to a slowdown in reforms, with a negative impact on GDP and growth. 

In addition, Brexit could threaten parts of the funding for accession. This could happen both directly because of the decline in contributions following Britain’s departure, but also due to potential EU renegotiations and future difficulties. Currently, there are around 4 billion euros available under the European Commission’s Instrument for Pre-Accession Assistance (IPA). Reduction in this funding will also hit growth in the region.

Dr. Sanfey went on to empirically model his argument with a GVAR model, based on a ‘soft’ and a ‘hard’ Brexit scenario. The former assumes limited disruption in the transition, selective further EU integration, and the EU remaining an important anchor for reforms, which in turn will have only minimum effects on the Western Balkans. However, a ‘hard’ Brexit following divisive negotiations, pressure on the single market, euro area, and Schengen, and internally challenged EU institutions would lead to less interest in pushing reforms abroad. In this case, the region suffers from a substantial indirect effect through the Eurozone in financial linkages, but also a substantial hit on its propensity to reform. The model estimates the cumulative cost of such a scenario at 5-6% of GDP for countries in the region by 2021.

Dr. Sanfey’s remarks were followed by a brief discussion by Dr. Merdzanovic, who highlighted the uncertainty surrounding the assumptions in making predictions on the subject. In regards to the UK, he noted that Britain has often been a promoter of enlargement, and its departure would thus be negative for the Western Balkans. Meanwhile, the role of the EU as driver of reforms in the region is highly problematic. First, this leads local actors to explain reforms as a tool to get closer to the EU, rather than as important improvements, making them often unsustainable. This is coupled with ‘shallow europeanization’ when reforms are adopted legally, but implementation is weak. Thus, the EU might be tempted to leave accession on autopilot and treat it as a technical process, which might entrench illiberalism and reform fatigue in the region. In short, according to Dr. Merdzanvic the political consequences of Brexit would be limited, but the real challenge would be whether the EU can react to the problems that led to Brexit in the first place.

Ivaylo Iaydjiev (St Antony’s College)

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