Foreign Direct Investments related to the tax burden in the Western Balkans

Foreign Direct Investments related to the tax burden in the Western Balkans

Average foreign direct investment in WB6 in 2022 is US$8.8 billion. Dollars, with a high increase of Serbia and Albania, which respectively have a share of 50.1% and 15.5% of FDI in BP6.

In total FDI, it is seen that only the Republic of Serbia counts half of their total stock in the region, while the rest is divided between five other countries, which corresponds to the size of their market and economies.

From the structural composition of FDI, there is still a predominance of the service sector and investments in the green economy. Meanwhile, the large European and Asian countries (China and India), which are part of the investment programs and territories of large foreign companies, remain in 2022. However, FDI does not only depend on domestic policies, but also on regional policies. Issues such as connectivity through transport and energy, disputes between countries, arbitrary decisions on customs duties directly affect and, in some cases, interrelated may not create incentives for foreign investors.

A recent panel discussion between the Prime Ministers of Albania, Serbia and North Macedonia, as well as the formation of a joint initiative to promote investments through the Open Balkans Political Platform [1], with the aim of enabling the free movement of people, goods, services and capital between its members, where they signed an agreement in 2019 initially under the name “Mini-Schengen” and from 2021 under the “Open Balkans”, but without the acceptance and participation of Montenegro, Bosnia -Herzegovina and Kosovo, which have rejected this initiative as a political and economic initiative that duplicates initiatives for entering the EU market.

However, to be competitive in the Balkan and European markets with the aim, regardless of initiatives for regional cooperation, to attract a valuable number of investments, it is inevitable that the necessary reforms be carried out. The main ones are to reduce corruption, to improve the efficiency of the administration, to reduce indirect costs and to create welcoming environments for foreign investments.

On the other hand, even though effective strategies have been built for the direct and personalized attraction of investments that are likely to occur, ie. to create an attractive and family-friendly business environment for investment.

FDI in the BP6 region should increase to strengthen the support of the economy. The average stock of FDI per capita in WB6 (512 US.D/inhabitant) is close to the value of FDI per capita in the EU [2] (585 Euro/inhabitant although it is only 3.3% of FDI in value of the EU.

In the service sector, the financial service sector prevails, as well as the trade and production sector, of which it is calculated that about one-fifth of the FDI stock is the chemical, food, and beverage industry, as well as products for the vehicle industry. The region’s efforts seem to need to focus on efficiency-seeking investments. FDI in export-oriented industries need the promotion of competitiveness and efficiency, which in fact depend on foreign-internal interaction regarding the benefit of knowledge and innovative technology to become part of the future economy for the local market.

The geostrategic importance of the region in the current context of economic revitalization and the attraction of capital oriented according to the needs of investors, instead of the needs for economic development that the citizens of WB6 are looking for is seeing the increased competition of investments from China, with an increase in interest and investors from the USA, who are becoming more and more present in reaching the region with the help of infrastructure, a policy which is seen by the authors of this report as a competition and occupation of the market instead of the part that belongs to Europe.

In support of the economic goal, WB6 countries have applied tax incentive schemes even increasing funds for Research & Development to disproportionate levels (R&D). Although tax incentives are no different from incentives for economic development policies, they are far from the strategy for a research and development system.

Tax incentives have failed to be uniformly linked to market and innovation. Currently, only a few WB6 still have in place tax incentives closely linked to specific R&D. Usually today the incentives are based on a combined model between the specific research expenditure scheme and the scheme based on their volume. The promotion of FDI from the policy of competitive taxes with low rates is more effective if FDI is attracted, which aims at efficiency based on low production costs, which means a low fiscal burden on labor.

Expenditure deductible from taxable income is the most popular current policy for promoting R&D, followed by recognition of most of it as recognized expenditure. Other incentive policies encourage a higher-than-usual rate of depreciation of R&D expenditures.

Most tax incentives are based on corporate income tax, while some countries have (additional) incentives that apply to social security contributions and/or payroll tax. The tax on the individual would be broader based if individuals would prefer to finance their research with their own resources or assisted with funds from organizations and private investors. Tax benefits applied to income from innovations (patents) are increasing both in number and in the types of patents being registered. In the last two years, eleven EU member states have offered corporate income tax relief for income resulting from intellectual property, as well as personal income tax relief for the self-employed.

While FDI is essential to drive economic growth as well as the transfer of skills and technology, governments should prudently check for potential negative impacts on societies and the regional economic environment. The strategy of advantages offered to foreign investors must now change. Policymakers and investment promotion institutions should use higher labor costs, but coordinating this market offer with increased capabilities and adapted to the demands of investors. Meanwhile, the authors of this study think that the favorable tax regimes have already reached their peak and there is no further need for easing policies, instead of strengthening internal capacities and reorganizing the bureaucratic burden and other problems faced by investors.

Some strong points for attracting FDI in the region include further integration with the EU in respect of the rule of law, reduction of corruption and curbing through voting the growth of autocratic tendencies, which do not serve a positive climate for valuable investments.

Beyond the low cost of labor and the low fiscal burden, it is necessary for WB6 to have a balanced economy, administration with low corruption costs and transparent politics in a developed financial market and connected to world markets.

The expansion of the foreign trade disparities of the Western Balkan countries in any case during 2022, as well as in 2021, were financed by the increase in foreign capital inflows.

But, when we look at foreign investments, their productivity in the host countries is also necessary by analyzing the trend of income per capita or the well-being of WB6 residents.

Moreover, FDI inflows were oriented towards investments in sectors such as financial services, real estate, and construction, which do not generate robust performance for export and increasing the competitiveness of the economy, but also income per capita for rural residents and those in the tourism and other non-financial services sectors.

Tab.10    WB6: FDI per capita, 2020-2021 EUR/Capita
Countries 2021 2022 Difference
Montenegro 955 1,348 41.2%
Serbia 569 650 14.4%
North Macedonia 313 440 40.4%
Bosnia-Herzegovina 153 180 17.6%
Albania 367 496 35.3%
Kosovo 236 435 84.7%
Western Balkans 432 592 38.9%

As seen in Table 10, the first place in 2022 for the level of FDI stock per inhabitant is held by Kosovo, with an increase of 84.7% compared to the previous year. Meanwhile, Montenegro and North Macedonia are ranked second and third, with respectively 41.2% and 40.4% growth compared to the previous year.

Albania and Serbia, even though they have a high level in the value of the stock of foreign investments, have an increase that shows a stable trend, although Albania has an increase that shows that it has better utilized the attraction of foreign capitals.

Bosnia-Herzegovina, with a critical position for holding the last place for the stock of FDI per capita, has a low growth in 2022 compared to the previous year.

The Economic and Investment Plan for the Western Balkans, as a financial assistance program of 9 billion euros [3] that supports economic development in the six countries, thus advancing their integration into the EU and eventual membership, should not be satisfied with the analyzes so far, which lack the local feasibility part that can be performed by local experts.

The investment fund for a period of several years is worth as much as is invested in almost one fiscal year in BP6 countries.

FDI inflows, while showing a positive trend, are still below their level to reach the ambitious goal of doubling FDI by the end of the current decade. In addition to the traditional channel of privatization through mergers and acquisitions of domestic businesses for FDI inflows, investors are also increasingly turning to renewable energy investments. This interest is partially generated by investment incentives that are currently offered and the proliferation of special economic zones in the region.

Meanwhile, withdrawing from electoral populism by seeking attention-grabbing policies through the policy of increasing wages, increasing spending on infrastructure, as well as creating a coordination area by investing in green energy and transport corridors that connect economic areas with interests for foreign and local investments is seen as an innovation in the Balkan political market. In the meantime, policies are sometimes mentioned that, in their tendency to free capital, aim to attract capital without direct investment, disorienting current policies and creating dangerous precedents for cleaning the capital of crime and corruption.

These trends have already been opposed by the EU and WB6 countries are required to fulfill the criteria that are mostly achieved in the largest number of OECD member countries, which, although they have a high fiscal burden, are much more effective in attracting foreign investments. A low tax burden cannot, on the other hand, compensate for an unattractive economic environment for investors. Tax incentives can be used in a more targeted and cost-effective manner for the expenses that will be incurred by investors, but also to meet the needs of the budget.

Taxes are just one of the elements that, even in the conditions of an offer with low rates, cannot compensate for the weak infrastructure, poor access to the market, as well as other conditions on which an investor bases his decision-making, such as sh. space to move freely in the financial market. If businesses (especially SMEs) [4] will not have sufficient and low-cost credit, then their growth will continue to be weak and, of course, investments and the labor market will be affected.

Balkan governments have responded to these competitive pressures and latest problems of market trends in diverse ways. Many countries have reduced corporate tax rates as the shortest and most easily monitored way to achieve investment targets.

A big problem that is growing every year now is the competitive offer for employees from the developed countries of the EU, as well as the overall increase in the level of immigration, as a solution to escape the economic reality that is changing slowly and more cost. More than one in five of the population born in BP6 countries lives outside their own country [5]. This mass exodus of [employees] has the effect of reducing labor market demand and has dictated increased costs for local businesses and foreign investors.

In fact, in this time of changes, BP6 countries should cooperate not only for the part of tax harmonization between them. Cooperation and coordination of fiscal stimulus policies, but also of employee movement should be the biggest objective of the current agreements between the countries. The relationship must be conceived to be implemented within the borders of the Western Balkans, without returning to selective and differentiating politics, putting the history of the past in the foreground and the exploitation of the neighbor’s weaknesses in the background.

If countries try to build policies to be part of the big market by building protective policies for sensitive sectors, they will have real opportunities to compete with the policy of lowering tax rates. The competition between each other helps powerful states and companies to enter easily through the politics of division of the Balkan states.

[1] https://www.swp-berlin.org/en/publication/the-open-balkan-initiative-complements-the-berlin-process
[2] https://www.ceicdata.com/en/indicator/european-union/foreign-direct-investment
[3] https://www.europarl.europa.eu/RegData/etudes/STUD/2022/702561/EXPO_STU(2022)702561_EN.pdf
[4] https://www.oecd.org/south-east-europe/programme/FINAL_SMEPI-pocketbook-2022-online.pdf
[5] https://www.oecd.org/south-east-europe/programme/Labour-Migration-report.pdf

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