Macedonia - Quo Vadis?
An Executive Summary of a Research Report
Dated 7/8/99

Issued by: Capital Markets Institute Ltd.
(Author: Dr. Sam Vaknin)

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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 coluntries 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”career.

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 fulfil 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