Supply-side Industrial Strategy:
The Case of Bosnia and Herzegovina
By DRAGOLJUB STOJANOV

Bosnia and Herzegovina is undergoing both transition from socialism and reconstruction from war, but development has barely restarted after five years of "demand management" policies prescribed by IMF and World Bank. According to Dr. Dragoljub Stojanov, Economics professor at the University of Sarajevo, a better policy would be "supply-side economics" based on increased productivity and competitiveness. The author was a government minister in 1996-97 and led a team which designed a strategy for national economic development as an alternative to the standard IMF/World Bank approach.
BOSNIA AND HERZEGOVING is in the process of transforming form a nonmarket, previously self managed economy to modern package being implemented is based on the "rules of the game" of the Washington consensus. At the international level, the IMF, the world Bank and US AID have so far led the transition. When the transition began, there was the promise and expectation of a "blooming landscape". Four years later, "blooming landscape". Four years later, it seems more like a mirage. Economic development has hardly started. Gross domestic product was valued at DM 6.9 billion in 1998, as against DM 13 billion in 1991. In the meantime, international donors have provided significant aid totaling $US5.1 billion, less than half of which has been disbursed and implemented since 1995.
In has finally become obvious that an alternative solution is needed for economic development in the country. This article dares to propose a solution based on supply side economics and neo-Key-nesian concepts. We share the opinion of professor Pitelis that increases in productivity and competitiveness are the key to the transition from formerly socialist economies in Eastern Europe. In the Medium term there is no other way. Macroeconomic policy can only contribute in the short run. This emphasizes the importance of supply side industrial policies for productivity, competitiveness and convergence, the element which has been mission from the package of "Washington consensus".

THE ECONOMY BEFORE 1991
The territory of Bosnia and Herzegovina is about one-fourth larger than Switzerland and nearly as mountainous. Four-fifths of the land is mountainous, and about 60 per cent is higher than 500 meters 1640 feet above sea level. Some 45 per cent of the territory is forested. Only a small fraction of the agricultural land is of high quality and suitable for modern agricultural technologies. The climate is continental Mediterranean and most suited for the production of cereals. The two main rivers have consideralbe hydroelectric power potential.
Between the Second World War and 1991, when Bosnia and Herzegovina was one of six republics of the former Yugoslavia, it achieved significant economic transformation. Economic growth averaged 5 per cent a year. In 1991 per capita income was $US2400, excluding the service sector, as was the practice in former socialist economies.
As the former Yugoslavia was dissolving in 1991 and 1992, Slovenia and Croatia declared their independence, and Bosnia followed. In April 1992 war began in Bosnia. In the same month the European Union and the United States recognized Bosnia as an independent state, and a month later it became a member of the United Nations.
Twelve big companies produce 35 per cent of the gross domestic product (GDP), and four of them generate more than 40 per cent of total exports. Companies have been organized as self man aged companies of associated labor, in accordance with the principle of a self managed market economy, which was halfway between a centrally planned and a modern market economy.
In 1990-1991, Bosnia's main foreign trade partners were the former USSR, Germany and ltaly. Its trade with the EEC counntries was in a surplus in 1991. Main exporting sectors were chemicals, ferrous metallurgy, metal processing, leather shoes, electrical appliances, finished wood, timber and panels, and finished textiles.

THE ECONOMY SINCE THE WAR
Before the war Bosnia had almost 4.4 million habitants. The estimated population now inhabiting the territory is 3.6 million. By the end of he war, in December 1995, and in its aftermath, 1.5 million people fled the country as refugees. Some 600000 still live in temporary locations outside the country, while an estimated 700000 are registered residents abroad. Other refugees have returned, often involuntarily. Most have gone to places dominated by their own ethnic groups and not to their former domiciles. During and after the war, some highly qualified people arranged their own emigration, often not counting as refugees at all.
Inside the country, the war displaced large numbers of people from their homes. Their number peaked at 1.3 million in 1995, and was reduced to 800000 by the end of 1998. On average, they suffered more than those who could flee the country.
In 1998 about 60 per cent of the population was in poverty, defined as income permitting a family of four to purchase less than two thirds of a defined consumer basket of basic needs. In the Federation, about a quarter of the people in poverty were employed. Average net salaries in the business sector could buy only about 68 per cent of the consumet basket, and about 87 per cent in non-business jobs. Only employees in financial institutions and public administration earned enough to be at or just above the poverty line. Both the pension and the unemployment compensation systems are in deficit, and paying too late and below the minimums.
Average daily income for impoverished persons is so low that they survive on financial support from relatives in the country, relatives and friends living abroad, international humanitarian assistance and activities in the shadow or informal economy.
Official statistics record quite impressive GDP growth rates: 21 per cent in 1995,69 per cent in 1996, 30 per cent in 1995,69 per cent in 1996,30 per cent in 1997, and 18 per cent in 1998. But GDP had fallen to such a low level during the war that the increases achieved since are proportionately high as percentages of a small base. The country produces much less than before the war. Many prewar production capacities have not been repaired or replaced, or are little utilized Employment is correspondingly low.
Recent GDP growth is predominantly aid driven, as reflected in the balance of payments. The current account deficit in 1996 amounted to almost half the nominal GDP, declining to about one fifth in the first half of 1999 in the Federation. Only about 25 per cent of imports were met by exports in the first five months of 1999 in both the Federation and the Republic.
When considering the development strategy and its effects so far, one has to take into consideration relevant external and internal factors both economic and political.
Two external factors have a determining influence. The first is the process of globalization of the world economy, and the "Washington consensus", which provides the basis for treating transition countries and their transformation into "Small open economies." The other is the 1995 Dayton Peace Accord.
Signed on December 14,1995 in Paris, the Accord ended military hostilities on the territory of Basnia and Herzegovina and fixed its external borders. The Bosnian, Croat and Serb sides agreed on an independent state, with Sarajevo as its capital. NATO forces were to implement state, with Sarajevo as its capital. NATO forces were to implement the Peace Agreement for a limited period, followed by the international bodies (OSCE, OHR and UN). The Accord outlines the constitution of the state, which provides for full freedom of movement of persons goods, services and capital.
Two internal entities were established the Federation, with 51 per cent, and Republic Srpska (RS), with 49 per cent of the territory. The Federation has 10 cantons.
While the Accord place banking and customs regulations at the central state level, fiscal policy was transferred to the entities and cantons, and no instruments were provided for shaping countrywide macroeconomic policy. This ties the hands of the central state concerning the formulation of a nuiform strategy for economic development, including industrial policy. In practice, Bosnia and Herzegovina lacks the power to formulate and implement independent monetary, fiscal, price and foreign exchange policies, and policies regarding privatization, incomes, and social welfare. Moreover, industrial policymaking is, in effect, impossible under the "Washington consensus" rules applied to the country by the World Bank and IMF.
The development prospects in such a poor country are remote, since the starting position is so low. It has no developed market institutions and no strong government which might implement an alternative package of development and macroeconomic policies. The policy package coming from and implemented by the IMF and the World Bank is seen as the only way of achieving stabilization, preparing the ground for privatization, and developing macroeconomic policy under more favorable political circumstances.
Yet the evidence points to the contrary. The "Frankenstein" economy simply does not perform as was expected. An alternative supply side approach to economic development strategy is clearly needed.
Supply-side industrial policy has been defined as a set of government policies intended to directly increase the production and supply of goods, and also usually to raise the per capita income of consumers. It requires "a well though-out, reasonably consistent and coherent set of industrial policies", and the "required resources and mechanisms for implementation." Under this definition, by Professor C. Pitelis of Cam-bridge University, part of the package should be policies for improving the competitive position of industrial producers over time and in relation to other countries, which in turn influences the achievement of the supply objectives. He suggests using the criterion of "total productivity of the economy" to measure performance, because productivity leads to improvements in competitiveness and implies "an increase in the welfare of all, at least in absolute terms."
What follows is an attempt to outline a more appropriate economic development strategy for Bosnia and Herzegovina, based on this definition of supply side industrial policy and of productivity and competitiveness as its complementary main determinant. This entails examining human resource, technology and innovation, unit cost economics, and infrastructure, all within a macroeconomic framework and an institutional setting. Wee will try to analyze the determinants of productivity in Bosnia and Herzegovina as a small open economy in the process of transition.
PRODUCTIVITY AND COMPETITIVENESS
Institutional setting
Corruption: There is evidence of widespread corruption at several levels, which raises the costs of doing business to a degree that it may become unjustifiable.
Interviews with over 50 companies have shown that officials of the Payment Agency, inspectors (customs, market, sanitary, communal, etc.) and minor government officials are corrupt. Inspectors have the right to shut down a company on the spot or to seize goods. The study concludes that ruling political parties act as an organized family. Noncompliance with the law is widespread, on all levels Those in power award lucrative contracts to cronies and family members, do not pay customs and taxes, launder money, gain access to prime commercial and real estate sites, and block business activities of outsiders, especially if they are unwilling to pay bribes. A process of law and an effective appeals system do not exist.
The court system has proved completely nonfunctional. Contract law is unenforceable. Corruption is omnipresent in the judicial system, judges are not independent of the ruling political party, and party officials often dictate judgements. As a result, cheating and fraud are the rule rather than the exception.
Business activities do not focus on production. Those who earn from the interplay between trade and politics do not need to enter the troublesome sphere of production, and others who try to engage in it become victims of all kinds of parasitism.
Excessive taxes: Equally discouraging is the official tax system. In the Federation, taxes include:
10 per cent tax on services
10 per cent tax on turnover
5 per cent tax on cash deposits
36 per cent tax on profits
87 per cent tax on employee salaries
Tax to support the chamber of commerce
Annual business registration taxes Miscellaneous municipal taxes and levies, often retroactive.
This huge tax burden makes business activities risky and often simply unprofitable. Some business people try to escape into the grey economy or the black market. This is easier in the case of trade, as it sometimes offers opportunities for quick profit. The best way to understand the situation of the manufacturing sector is to imagine a nearly starving cow surrounded by a bunch of hungry people who desperately try to press milk out of her.
Financial hindrances: A further reason for the slow development of manufacturing is in the financial sphere. Many companies, if confronted with lucrative orders from clients, would have difficulties meeting the demand, mainly because they lack financial means to buy the necessary inputs. Most are in desperate financial state. They may simply not be creditworthy. Or they prefer not to apply for credit, because interest is so high that it destroys the profitability of projects. The interest rates would probably be two digit, and in a country with zero inflation this has to be prohibitive for most companies engaging in production. Only traders with short term credit requirements can afford such high interest rates.
Privatization: Way is progress so slow? From the very beginning, the international organization administering reconstruction aid have emphasized the need for quick and comprehensive privatization. Only private entrepreneurs, so the argument goes, behave in the way required for a functioning market economy. Given the fact that fast privatization of financial and nonfinancial enterprises was given absolute priority, it may look puzzling that not much happened in this respect up to 1999.
Transition countries such as Hungary, Poland or Russia have promoted privatization vigorously. Why not Bosnia, despite much more support and also pressure from outside? One reason may be that structures in the former Yugoslavia differed fundamentally from those in Moscow controlled countries. The proclaimed self management of companies by their employees had not really functioned well, but nevertheless the enterprises had much autonomy. They gained experience with commodity markets for inputs and outputs, as well as with labor markets. Employees and the local population developed some emotional adherence to "their" enterprise. Maybe this helps explain why effective privatization is slow even in Slovenia, otherwise the most developed transition country. Privatization necessarily means a redistribution of power, and in Bosnia more than elsewhere the leading forces may be afraid of it, because property issues are unavoidably mixed with ethnic aspects, and therefore extremely sensitive.
The banking sector: There are more than 67 banks in Bosnia (49) in the Federation, 18 in RS), bur less than 10 per cent of them are financially sound. Most do not have enough capital to function and are still burdened with liabilities from the prewar period. Many clients who had deposits, whether in domestic or hard currencies, lost access, and their claims should be settled somehow. Because the public has lost confidence in banks, it is difficult to consolidate them. Interest rates vary widely and are generally so high that they cause a serious problem for production companies that need working capital.

Macroeconomic environment
In 1996, a basic strategy for recovery and the role of government was published. It was set out in the chapter entitled "Towards Establishing a Market Economy", in the document "Bosnia and Herzegovina: Towards Economic Recovery", prepared by the World Bank, European Commission and EBRD. The package contains all the elements in both theory and practice which were adopted in other Eastern European countries. One unique and important element, which was not needed in those countries, concerns postwar physical reconstruction of Bosnia and Herzegovina.
The document envisaged that quick privatization, the dismantling of state firms, and the development of small and medium enterprises, light industry and the service sector would be the basic levels for the growth of the economy. It continued:
"The role of the state in the economic and development strategy which is governed by the private sector is not unimportant, but shifts its focus. It should concentrate on the maintenance of healthy macroeconomic conditions and on the establishment of a relevant legal and institutional framework, which motivates uninterrupted functioning of a free market and provides basic public goods and social services, such as defense, public order, education, health services."
The reform of banks and firms was a major project which must be implemented, the document stated. Sizable inherited bad credits, as well as old foreign currency accounts must be excluded from the balance sheets of banks. At the same time, large and inefficient state firms must be closed or restructured and privatized.
In restructuring firms and banks, the document considered the most appropriate approach would be for state institutions to adopt a flexible program of privatization to be applied regionally. The RS would be one region, and region in the Federation might consist of a group of cantons, an individual canton or more local levels. This regional approach has consequently provided the basis for so called "ethnic privatization", which now constitutes an annoyance and a divisive factor. At the same time, the regional approach towards privatization has divided formerly big companies into component parts according to their locations.
Under the World Bank/IMF program, the central bank functions as a currency board for six years, starting from 1996-97. This means integrating Bosnia into international markets as a "price taker", with a fixed exchange rate of antional currency pegged to the Deutsche mark (DM). The country thereby loses the potential advantage of the effects of the so-called "Philips curve".
The package contained a hard budget constraint, a rule which Bosnian authorities accepted. A budget deficit cannot become a source of inflation.
The external sector was given as significant a role in the economic transition of Bosnia as in other transition countries. Foreign trade is to be liberalized as quickly and fully as possible. Foreign direct investment (FDI) and transnational corporations (TNCs) are supposed to be main driving forces for economic recovery.
Left without its own monetary, foreign exchange rate and balance of payments policies, with different privatization policies in its two regions, unable even to consider an industrial policy, Bosnia was placed in the hands of free market forces and the international donor community.
Four years since peace came, gross domestic product (GDP) reached slightly more than 50 per cent of its prewar level. However, since the socialist method of calculating GDP before 1991 excluded the service sector, today's GDP in reality is less than 50 percent of its 1991 level.
Below is a series of basic macroeconomic data for January September 1999, and comparisons with 1998 figures;
Industrial production in the period increased by 4.9 per cent over 1998 in the Federation, and 1.5 per cent in RS.
Retail prices decreased slightly in the Federation (less than 1 per cent), but increased substantially in the RS (13 per cent), compared to the 1998 level.
Employment. In the period, employment in the Federation reached 408004, 3.2 per cent above the 1998 average, with about 69 per cent in the business sector, and 31 per cent in nonbusiness. In RS there were 244267 employees in 1997, 149214 people were looking for a job, 5 per cent more than at the end of 1998. Skilled workers made up 35.6 per cent of the unemployed, and 1.1 per cent had university degrees.
Net wages. Average net wages had increased by 5 per cent in the Federation and by 30.1 per cent in the RS over 1998.
Balance of payments. In the period, the deficit in the current account reached US$1341 million two thirds from the Federation, a third from RS. Trade balances alone recorded a deficit of US$ 1408 million. Exports. A projection for the remainder of 1999 showed the value of exports running around 15 per cent below World Bank predictions. However, from the very beginning of the World Bank recovery program, the question has been where such huge exports could come from, under a "demand management" type of policy?
Economic recovery in Bosnia is approaching the limits of its own foreign debt service possibilities. If foreign aid were to be reduced or stopped for any reasons, the GDP would enter the minus zone. The economy is not prepared for self-sustaining development.
Human resources. In addition to refugees, emigrants and internally displaced persons (see above), unemployment is a major human resources issues for Bosnia. Despite the "demand managed" reconstruction and recovery program initiated in 1996 and led by the World Bank and the IME over half the country's potential work force was unemployed at the beginning of 1999, according to the broad definition of unemployment.
In 1999 registered employment increased by about 4 per cent.
The renewal of the work force by the entry of younger employees is a factor which tends to favor increases in productivity. However, the opposite trend exists in Bosnia, where the majority of the unemployed are aged 21-25 and 31-35. A recentfederal law aimed at saving the pension system by decreasing the number of pensioners could lead elderly workers to prolong their employment, thus reducing employment possibilities for younger productive people.
Even more counterproductive for productivity and job creation are the provision of the recently enacted "Work Law." People employed by a company in 1991 before the war started, now have the right to return to the same job, or to be compensated by the company if they are no longer needed; but the majority of big companies were destroyed or demolished during the war, drastically changing their need for workers. The law imposes a serious financial burden on companies already facing financial pressures. It endangers the privatization process by making companies less attractive for privatization and restructuring. It affects potential industrial investment by diverting scarce financial means from investment to private consumption. The World Bank and private business strongly oppose this law. The law represents a heritage from the former "self-management" system in former Yugoslavia and is evidence of inadequate institutional change in Bosnia's transition process.
As for education, the war caused a serious drop in primary and secondary school enrollment rates. Prewar primary enrollment was 98 per cent, and the 1999 figure was 82 per cent of school age population, while secondary levels dropped from 90 to 75 percent. Likewise university students, which decreased by 30 per cent from the 1991 level.
The preceding numbers at least partly reflect the anarchy of the country's used inadequately, even in a wasteful and useless way. For example, a majority of highly educated Bosnians no work for international agencies in jobs that do not use their educational qualifications, which are therefore lost to the productive economy and decrease from disuse and the passage of time.
Another factor which affects human resources potential is that people are very immobile. This is caused by the housing shortage, with many houses destroyed in the war; high unemployment and lack of job opportunities; very low pay and the impossibility of paying rent if not living in one's own residence; and loss of attractive markets in the former Yugoslavia and companies which produced for them.
Institutional changes in Bosnian society are rather slow. Inherited privileges from the self managed period are still deeply rooted. Workers are not aware of the revolutionary changes taking place globally and even in their country's constitution. They claim rights to a permanent job and other privileges they had under the previous self managed system.
Nationalistic political parties still control the governments and are main manipulators of state companies which still exist, selecting their general managers and boards of directors. Even the Federal President sits on the boards of some top priority state companies, usually the best performing and most healthy ones. There is a belief that privatization and restructuring of the state companies could remove the obstacles to development and adequate sue of human capital.
But many other factors are involved; the newness of the privatization process and its unpromising political and economic circumstances; the missing institutional changes which are needed; corruption among politicians; the dangerous lack of liquidity; and the lack of an economic development strategy (other than that prescribed by the World Bank, which relies of free market forces and foreign direct investment, which are both missing). Bosnia's recovery program is still based on the "development without a concept" program set by the international community, which says "let the free market do the job" and "let the chips fall where they may. " Under such circumstances, a black or gray market develops for human capital, degrading the quality and decency of human resources. The value system has changed so that the top priority of the Bosnian elite, managers and politicians has become quick wealth creation through short term speculation. They are neglecting long term objectives and visions based on the postulate of hard work and sustained development.

Technology and business development
Generally speaking, the disintegration of the former Yugoslavia in 1991 stopped the processes of transfer of technology and technology creation. Since 1995, reconstruction has been at the top of the agenda of the government and the international community, and donor disbursements totaled over US$ 2.13 billion between January 1996 and August 1999 (according to the Federation government document, "Economic Policy Measures for 2000"). Of this total, 82 per cent went for rebuilding and reconstruction of housing, energy, transport, water supply, health, education, social services, and agriculture (about US$ 1.75 billion for 4500 projects); and 18 per cent went for credit projects for the business sector (about US$385 million for 919 projects) Therefore, it is not surprising but rather a logical consequence, that the business sector is in a state of infancy and far from a self sustainable level. The international community, simply speaking, refuses to provide capital to state owned companies, regardless of their actual and potential viability and efficiency. The available modest amounts of credit are supporting only small private business entities.
On average, 85 per cent of equipment in the business sector is obsolete. The rate is so high because companies were technologically relatively obsolete before the war, the war destroyed much equipment, and the international community does not support nonprivatized business.
One of the most controversial aspects of the role of the international community in Bosinia is Bosnia is that its investment policies are very short sighted and narrowly based:
It provides only modest financing and only for private small medium enterprises (SMEs).
Repayment periods are very short term.
Interest rates are very high on domestically borrowed capital 1.5 to 3 per cent monthly.
Investment per job created in only KM 20000 or 30000, with low technological content (1KM=1 Deutsche mark).
Products receive no effective tariff protection.
All these factors force business managers to have only short term horizons and neglect even the slightest possibilities of modernizing their companies. Under such circumstances it is quite understandable that any R&D activities are voluntarily selected entirely by individuals based on their personal enthusiasms.
The above-mentioned realities and rigidities, plus institutional malfunctioning and, even worse, the absence of relevant institutions, make quite convincing the broadly supported and accepted argument that without foreign direct investment (FDI), the Bosnian economy cannot move ahead.
This is how we get into the vicious circle:
Without capital there is no technological change.
Without technological change there is not progress.
There is no capital without transnational corporations and foreign direct investment.
There is no FDI without free markets and a prosperous economic climate.
There is no free market with state intervention.
With state intervention, there is no capital because TNCs will into come.
Without TNCs there is no capital, and without capital there is no technological change.
In May 1999, the European Commission and the World Bank published a study entitled "Herzegovina 1996-1998: Lessons and Accomplishments Review of the Priority Program and Looking Ahead towards Sustainable Economic Development." The study describes three groups of barriers to the development of domestic private business and to the attraction of FDI to Bosnia:
Fiscal barriers complicated fiscal procedures, unforeseen and retroactive taxes, uncoordinated taxes between RS and the Federation.
Barriers related to the inappropriate and unreliable judicial system, including the lack of professionalism and the insufficient transparency of ownership rights.
The extremely complicated administrative process for registering new business activities.
The absence of technological progress and the lack of a positive vision of the country's future leave the citizens with a very gray perspective about the possibilities of improvement and progress, and this contributes considerably to the brain drain from the country.

Infrastructure
According to the "Global Competitiveness Report 1999," there are several basic parameters for measuring the creative technological potential of a country. Nine of them are listed below, with comments on how Bosnia is faring;
Investment in basic R&D, The country cannot realistically expect this to happen until the distant future, unless the international community were to change its attitudes towards the development of Bosnia and the Balkan region as a whole.
Average educational level. This is 25 per cent lower in 1999 than it was in 1991. However, in vestment in education is being heavily supported by the international community and offers the possibility of achieving an improved level as future student enrollments rise. There are predictions that by 2007 the same level of enrollment will be achieved as existed in 1991.
Concentration of scientific and engineering talents. Only a very small cohort of young scientists exists as the basis for eventually building a significant cluster of talents .Many young scientists have left the country, and most have been well received in USA and EU. On average, close to 60 per cent of scientists with a technical education become part of the brain drain. It may taken as long as 15 years for the country to restore its prewar level of scientific talent.
Information-communication infrastructure, with financing from the international community, the web of information communication has been rebuilt and modernized. Once the state PTT company is privatized, more improvements in telecommunication services are expected.
Protection of intellectual property rights. Practically speaking, appropriate regulation does not exist in the country.
Promotion of R&D activities. No special fiscal policy or law exists to stimulate R&D activities, except for one incentive that encourages reinvesting earnings in support of R&D.
Venture capital. The supply is still rudimentary, both from commercial banks in the country and the 17 local and 9 international non-governmental organization which are active. World Bank data show that NGO-financed credits stimulated creation of 40,000 new jobs in 1996-1998. But almost 60 per cent of the credits went to the trade sector, and they averaged only 3000 KM-a very small contribution to promotion R&D.
Openness for FDI and foreign trade. Since 1995, the country has had almost no tariff policy, and could be simply depicted as a state without borders. Domestic producers face an unfair trade position disadvantaged by the doctrine of free trade an the lack of an appropriate institution to support and monitor the development of foreign trade. Foreign goods are cheaper than domestically produced goods by 30 per cent or more. Combined with the great outflow of domestic capital, the development of production and of the domestic productive sectors is seriously hindered. Some positive change may result from a recently enacted Tariffs Law which favors fair trade relations with foreing partners on the basis of free trade.
Level of demand sophistication. The domestic market is full of goods which lack certificates of origin and which do not pass quality controls. However, given the low purchasing power of the population, goods are easily sold on the domestic market.

Economies of scale
Gentral to the situation of Bosnia and Herzegovina at present is the fact that its economies are limited to a small scale in a number of ways:
Financial sources are too small to achieve the necessary technological innovation. This means that the present state of technology obsolescence is retained.
Average capacity unilization in the economy is low about 40 per cent in industry and 30 per cent in agribusiness.
Large companies are languishing or not even restarted after the war. Their managers say that only small amounts of money (5 million DM, for instance) would enable them to restart production. However, the international community is not helping to finance existing big companies. The position taken by the World Bank and the IMF concerning the future of state-owned enterprises precludes any possibility of restarting those firms. The only route left for Bosnia is the development of small and medium enterprises.
An important stumbling block in the way of quicker privatization of state owned companies is the prospect of still more joblessness and the difficult social situation this would create. Some estimates are that privatization could increase joblessness by 30 per cent or more.
Before the war, when Bosnia was one of six republics of a single state and part of a single economic area, the market of the former Yugoslavia was very important. For example, Croatia and Slovenia accounted for over 37 per cent of Bosnia's exports to areas of the former Yugoslavia, and Serbia's share was even larger. This export base now is considerably weakened.
Finally, it is obvious that prosperity in Bosnia can hardly be imagined without economic development of the Balkan region as a whole. The Stability Pact deserves special attention in that regard. Creation of a Balkan Payment Union, like the European Payment Union after World War II, could be a welcome building block for Bosnian and regional prosperity.

POSSIBLE INDUSTRIAL STRATEGY BASED ON CLUSTER DEVELOPMENT
Before the 1991-1995 war, the Bosnian economy was dominated by 12 huge companies, including Energoinvest, Unis, Sipad, Famos, Rudi Cajavec, Soda So, Agrocomerc, and UPI. Those companies produced for the domestic market in Baosnia and the former Yugoslavia and for foreign markets. Beside the giants, there were many privately owned small and medium enterprises (SMEs), more often small than medium in size. The law at the time allowed SMEs to be organized as private sector operations if they had no more than 25 employees. Small private businesses were mainly in the service sector.
Given this background, Bosnia and Herzegovina is not familiar with the cluster type of industrial organization and the economic development process based on such an organization. The cluster idea involves, as a first step, identifying which types of industries and which specific enterprises have a competitive edge, based on such factors as their internal efficiency and profitability (including technological and labor equations), their effective use of available natural and human resources, or their market and export performance. In some cases, some of these might be small and medium enterprises (SMEs) which could achieve production economies and greater profitability if they were grouped into a logical cluster, with shared services and a rational and dynamic division of labor. In other cases, SMEs could be clustered and joined up in the same sector or sub-sector with big privatized firms which are strong and efficient.
Analysis of the country's national and human resources revels some comparative advantages which could profitably be emphasized in the restructuring of the industrial sector and the development of clusters. A competitive edge seems to be offered in:
Resources industrial based on hydropower, forests, ore, nonferrous metals, and nonmetallic minerals.
Technology intensive industrial whose management is export oriented and which can draw on "good will" they acquired in some foreign markets in the prewar period.
A number of small and medium enterprises which could profitably combine forces with by firms which are successfully engaged in similar lines of production.
Labor intensive industries which could achieve production economies by increasing the volume of their specialized output, have a trained and cheap labor force, and can sell in nearby foreign markets (especially in the former Yugoslavia and the Balkan region.)
Given the fact that Bosnia is a small country, its industrial strategy and clustering might be based on selecting rather narrow objectives or on targeting those portions of the international markets which offer the best chances of achieving positive effects.
The creation of a new industrial strategy based on cluster development is constrained by the low purchasing power of citizens, the current political organization, the existing high risk for foreign investors, the lack of capital needed to support cluster development, and the "Washington consensus" type of economic development strategy which still prevails. However, forgetting those constraints for the moment, we have tried to find an appropriate and objective way of assessing potentials for cluster development.
We needed to be able to measure the economic strength and flexibility of different muncipalities as the regional-local bases for industrial production. This involved studying the structures existing in the prewar period, assessing the comparative performance of municipalities in the recovery and reconstruction process, and analyzing the propensity of the municipalities to private initiative and entepreneurship. A key question about the future concerned the ability and adaptability in a muncipality to create value added in the period after privatization and compartmentalization of previously "big" companies.
To see how a municipality contributes to the national economy, we calculated the respective rations of its participation in creation of (1) gross domestic product (GDP), (2) gross national product (GNP), and (3) net value added, to its participation in the fixed assets of the national economy. However, from 1990, the data could be taken as a good illustration of the efficiency of the use of fixed assets in individual municipalities. Given the enormous damage caused by the war, the coefficients suggest how rapidly municipalities could undertake privatization and create SMEs from privatized big or relatively big state companies.
Analysis of municipalities within RS showed that the industrial structure of the majority of them was very bad. In most cases, their contributions to the creation of GDP and net value added were below the average for the country. They performed very poorly even before the war, while the Bosnian economy was integrated in the unique Yugoslav market and purchasing power was much higher than today. No developments since then suggested that future performance would be better.
As for the municipalities within the Federation, they divided into one group with below average performance, one municipality with a very mixed profile, and another group which was above average.
Low: All three coefficients were considerably under in nine municipalities. They were characterized by too many industrial facilities for electric energy generation, black metallurgy, and extraction, which also are not very attractive for foreign investors.
Mixed: Another municipality presented a mixed picture. There, although industrial capacity was very well preserved after the war, poor management resulted in a highly negative coefficient. At the same time, its industry agribusiness is quite attractive and may offer a good basis for negotiation with foreigner investors and for transforming the certificates of employees into shares.
High: Eight municipalities had very high performance, with coefficients twice as high as the national average. In general, they have relatively great fiscal capacity in their municipal and cantonal budgets because of more intensive economic activity; have a well developed tradition of operating SMEs; exhibit an entrepreneurial spirit which promotes great efficiency, and in the period of postwar transition and reconstruction their entrepreneurial spirit which promotes great efficiency, and in the period of postwar transition and reconstruction their entrepreneurs have already achieved positive results. Typical examples of rapid recovery in three different municipalities are a company which has re-employed nearly all its prewar workers, and textile and wood products companies which have reestablished their business ties very quickly and generate considerable income. There municipalities and companies are considered primary candidates for a new cluster approach to economic development

CONCLUDING REMARKS
Since the Dayton Peace Accord at the end of 1995, the economy of Bosnia and Herzegovina is supposed to have been reconstructed from war damage and transformed into a modern market economy this was to happen as a result of a whole array of demand management policies prescribed by the IMF and World Bank. The goal was for the Bosnian economy in converge with the economies of the European Union, the sooner the better.
However, in four years since the end of the war, the GDP has reached less than 50 per cent of its prewar level, in spite of great endeavors by the international community. The strategy for economic recovery and takeoff initiated by the World Bank and IMF relies heavily on a "demand management" type of policy. The supply side, production improvement and industrial development were left far behind in the list of priorities. It was believed that economic recovery and development would proceed automatically as soon as the idea of free markets and FDI as the main driving force for the economic advance were accepted.
What has almost been forgotten is that institutions have an irreplaceable role to play in development. The attention given to the development of a key institution the market has been sporadic and virtually nil. The results are counterproductive: privatization has taken place on the basis of ethnic separatism, and the country's economy has been divided into two entities.
If the goal is to achieve economic, social and political recovery and encourage the return of refugees, the country badly needs to adopt and industrial strategy based on supply side economics. Such a strategy should start with and build upon the most important element for improving social welfare the productivity of labor. The leadership in such a strategy should be provided by the state (as envisioned by Pitelis and Sugden or by Murakamy, Nolan, Panic, Horvat and others). Production would then be reshaped in a decisive and important way.
However, there are some serious obstacles to efforts to achieve such a solution, as follows;
Lack of resources, especially capital and new technology.
Lack of efficient government.
Lack of credible market institutions. Leading international institutions for development, which is not based on a supply side approach.
The interests of transnational corporations (TNCs) are not compatible with a national development strategy based on domestic cluster industries independent of TNCs (see Dunning, 1998).
Special attention needs to be given to countries dependence on the leading international development on the leading international development institutions and to the increasing role of TNCs in a globalizing world economy. These two powerful groups stand in the way of the supply side option being adopted by an individual country, even if it seems to be the best possible approach.
The biggest issues for Bosnia and Herzegovina could be resolved if the broad assistance being provided by the broad assistance being provided by the international community were directed towards:
Pursuing a supply side strategy as the most productive way of overcoming transition difficulties,
Efficient and quick privatization and restructuring of potentially "strong" companies, around which adequate clusters could be more easily developed, and
Stronger support for job creation and economic development based on supply side strategy.
This mix of components offers an alternative approach to the singular focus on demand and markets embodied in the current strategy. No single prescription cures all illnesses.

Note
This paper represents the first stage of a study being done in cooperation with Professor C. Pitelis of Queens College, Cambridge University, and Professor R. Sugden, Birminghan University and University of Ferrara. We swish particularly to thank the ACE-PHARE Office for financing the project.

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NOTES
C. Pitelis, "Supply side Strtegy for Productivity, Competitiveness and Convergence between the CEESs and (in) the EU", p.5.
J. Poschl, "Herzegovina After Four Years of Reconstruction," Vienna Institute for International Economics, 1999.
D. Stojanov, "Strategy for Economic Development of Herzegovina," UNDP, 1997.
C. Pitelis, P. 2.
This part of the article relies heavily on J. Poschl, "Herzegovina Four Years after Reconstruction. "
Taken from: J. Poschl, "Why Will No One Invest in Herzegovina", ICG, April 1999.
World Bank, European Commission, EBRD, "Bosnia and Herzegovina towards Economic Recovery," World Bank, 1996.
Bulletin of the Central Bank of Bosnia and Herzegovina.
The World Bank, "Bosnia and Herzegovina Towards Economic Recovery."
J. Poschl, ibid.
Government of Federation of Bosnia and Herzegovina, "Economic Policy Measures for 2000," Sarajevo, 1999
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