Yugoslavia - Adjustment policies and development perspectives (Vol. 2 of 3) : The main report

Report No.3954-YU Yugoslavia: Adjustment Policies and Development Perspectives F (In Three Volumes) Volume II: The Main Report November 2, 1982 Country Programs Department I Europe, Middle East and North Africa Region FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency, Equivalents 1/ 1976 1 US Dollar = 18.19 Dinars 1 Dinar = 0.055 US Dollars 1977 1 US Dollar = 18.30 Dinars 1 Dinar = 0.055 US Dollar 1978 1 US Dollar = 18.64 Dinars 1 Dinar = 0.054 US Dollar 1979 1 US Dollar = 19.00 Dinars 1 Dinar 0 0.053 US Dollar 1980 1 US Dollar = 24.91 Dinars 1 Dinar = 0.040 US Dollar 1981 1 US Dollar = 35.51 Dinars 1 Dinar = 0.028 US Dollar 1/ Period average exchange rates. The dinar has not been maintained within announced margins since July 12, 1973. Following a devaluation on October 22, 1982, the rate stood at 63.51 Dinars per US Dollar. Glossary of Abbreviations BOAL Basic Organization of Associated Labor COAL Complex (or Composite) Organization of Associated Labor CGE Computable General Equilibrium CIFER Community of Interest for Foreign Economic Relations COI Community of Interest DOD Debt Outstanding and Disbursed DRC Domestic Resource Cost GMP Gross Material Product ICOR Incremental Capital-Output Ratio KBP Kosovska Banka Pristina LDR Less Developed Region(s) MDR More Developed Region(s) MLT Medium- and Long-Term OAL Organization of Associated Labor QR Quantitative Restriction SSE Small Scale Enterprise(s) YBIEC Yugoslav Bank for International Economic Cooperation Throughout this report, the term 'region' is used to refer to Yugoslavia's six republics and two autonomous provinces.  FOR OFFICIAL USE ONLY YUGOSLAVIA ADJUSTMENT POLICIES AND DEVELOPMENT PERSPECTIVES This report is based on the findings of a World Bank economic mission which visited Yugoslavia in June 1981. The mission consisted of the following: Suman Bery, Chief of mission Petros Aklilu (Agriculture) Deepak Bhattasali (Foreign Trade and Finance) Kosara Gavrilovic (Translator and Interpreter) Paul Harrison (Consultant) (Agriculture) Frederick Kilby (Employment and Regional Development) Francois Laporte (Industry) Surinder Malik (Industry) Leslie Manison (IMF) (Foreign Trade and Finance) Mieko Nishimizu (Total Factor Productivity; Regional Development) Sherman Robinson (Adjustment Policies; CGE Model) Laura Tyson (Consultant) (Adjustment Policies; CGE Model) Assistance to the mission's work in Washington was provided by Jeffrey Lewis and Mukaila Ojelade. Ann Pepper had primary responsibility for document production. A draft of the report was discused with official and academic bodies in Yugoslavia in June and July 1982, and additional material has been included based upon that visit. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  YUGOSLAVIA ADJUSTMENT POLICIES AND DEVELOPMENT PERSPECTIVES Table of Contents VOLUME II: THE MAIN REPORT Page No. COUNTRY DATA INTRODUCT ION PART I: ADJUSTMENT PERFORMANCE AND POLICIES I. The Adjustment Strategy pf tpe 1976-80 Plan .... ...... 1 A. Background to the Plan ............. ..1............ Economic Trends .............. ..1............. Institutional Change ..... ............. 3 B. The Adjustment Strategy ..... ............ 6 II. Plan Performance: Overview and External Sector I _ __Deve__lopments ...___________... 13 A. An Overview ................... ................... 13 B. The External Sector .............................. 15 Sources of Change in the Current Account Deficit ....................................... 15 Merchandise Exports ............................ 19 Performance in Developed Country Markets ....... 22 Invisibles ..................................... 24 External Debt .................................. 28 III. Plan Performance: The Domestic Economy .... .......... 35 A. Sectoral Growth Performance ......... .. ........... 35 B. Investment ................... .................... 39 C. Capital Efficiency ............. .. ................ 42 D. Saving Performance ............................... 47 Aggregate Trends ............................... 47 Household Savings .............................. 48 Enterprise Savings ............................. 49 IV. The 1976-80 Plan: The Policy Framework .... .......... 55 A. Investment Allocation ............................ 55 B. The Foreign Trade and Payments Regime ............ 66 Institutional Developments . . 66  - ii - Table of Contents (continued) Page No. Incentive Framework ............................ 67 Foreign Exchange Allocation .72 Export Incentives .75 Trade Bias .79 C. Exchange Rate Policy .84 D. Summary Assessment .93 V. The 1981-85 Adjustment Strategy .97 A. Overview .97 B. Medium-Term Prospects ............................ 107 Sectoral Implications .......................... 112 Capital Account Issues ......................... 115 Policy Issues .................................. 117 PART II: DEVELOPMENT PERSPECTIVES AND ISSUES VI. The Industrial Sector .............................. 120 A. Introduction ............................... 120 B. The 1976-80 Plan .................................. 122 Aggregate Targets . ............................. 122 Investment .................................... 123 Output ..................................... 124 Employment .................................... 125 Imports ..................................... 126 Exports ..................................... 127 C. The 1981-85 Plan .................................. 128 Priority Industries ........... ................. 134 D. Export Potential, Markets and the Incentive System 144 Plan Targets ................................... 144 Past Performance ................................ 145 Export Markets .................................. 146 Export Incentive System ........ ................ 149 Export Promotion Infrastructure ..... ........... 152 E. Some Policy Issues in Industry . 152 Incentive Policy . 153 Export Credit . 156 Investment Choice . 156  - iii - Table of Contents (Continued) Page No. VII. Agriculture . .......................................... 159 A. Structure of the Agriculture Sector .... .......... 159 Resource Base .................................. 159 Land Tenure and Production Orientation .... ..... 159 Agricultural Population ........................ 160 Role of Agriculture in the Economy .... ......... 160 B. The Agriculture Sector 1976-1980: Plan and Performance ......... ............................ 162 Plan Objectives and Strategy ..... ............... 162 Assessment of Performance ...................... 163 Policy Framework ............................... 163 Agricultural Pricing and Subsidy Policies ... ... 163 Investment Allocation .......................... 165 Association of Farmers ......................... 167 Land Reclamation and Abandonment .... ........... 168 Agricultural Exports ........................,. 169 C. The 1981-85 Plan ....... ................ 170 Evaluation of Plan Targets and Measures .... .... 170 Land Use ........... ............................ 171 Food Processing Capacities ..................... 176 Summary Evaluation ............................. 177 VIII. Employment . .......................................... 180 A. Introduction .......... ........................... 180 B. Labor Force Trends 1971-75 ...... ................. 180 C. The 1976-80 Plan .......... ....................... 184 Social Sector Employment ...... ................. 184 Private Nonagricultural Employment .... ......... 194 Private Sector Agricultural Employment .... ..... 195 Unemployment ............ ....................... 203 Overall Performance 1976-80 ..... ............... 208 D. Labor Force Balances 1970-80 ..... ................ 210 E. Regional Employment Issues ....................... 212 Regional Demographic Trends .................... 215 External Migration ............................. 218 Interregional Migration ........................ 220 F. The 1981-85 Plan ................................. 225 IX. Regional Development Issues .......................... 233 Introduction .................... ..................... 233 A. Regional Trends in Output, Population and Per Capita Incomes .............................. 234  - iv - Table of Contents (Continued) Page No. B. The Framework of Regional Policy ................. 242 The Scale of Impact of Regional Transfers ...... 242 Other Regional Policy Measures ................. 245 C. Productivity Growth and Development Policies in the LDR .................... ..................... 246 The Sources of LDR Growth 1965-78 .............. 248 Changes in the Efficiency of Production ........ 253 The Role of Enterprises in Productivity Growth . 261 Regional Planning ............ .. ................ 262 Competition Policy ............ .. ............... 264 The Impact of Regional Fiscal Policy on Resource Allocation .................................... 267 D. Recent Regional Policy Initiatives and Suggestions for Further Policy Reform ....................... 271 Domestic Joint Ventures ........................ 271 Policy Issues .................................. 273 An Action Program for Kosovo .... ............... 278 X. Adjustment Policies and Development Perspectives .... 283 A. Stabilization and Trade Policies .... ............ 284 B. Investment and Financial Policies .... ........... 285 C. Institutional Reform ............................ 289 D. Employment and Regional Development Policies .... 290 E. Concluding Remarks .............................. 290 LIST OF TEXT TABLES Table No. Chapter I 1.1 External Sector Developments, 1965-80 ........... 4 1.2 External Sector Targets of the 1976-80 Plan ..... 6 1.3 Structure of Investment in Fixed Assets in Economic Sectors 1971-75 and 1976-80 ........ 9 1.4 Macroeconomic Indicators 1971-75 (Actual) and 1976-80 (Planned) ............................. 10 1.5 Estimated External Financing Requirements of the 1976-80 Plan .................................. 11  -v- List of Text Tables (Continued) Table No. Page No. Chapter II 2.1 Main Indicators of the 1976-80 Period ........... 14 2.2 Sources of Change in Current Account Deficit, 1975-80 ....................................... 16 2.3 Evolution of the Real Deficit, 1975-80 .......... 18 2.4 Aggregate Regional and Commodity Distribution of Exports, 1970, 1975 and 1979 .... .............. 20 2.5 Growth of Yugoslav Exports by Market and Commodity Group, 1970-79 ..... ................. 21 2.6 Constant Market Share Analysis of Yugoslav Exports to Developed Country Markets, 1970-79 . 24 2.7 Developments in the Invisibles Account, 1976-80 . 25 2.8 Migration and Workers' Remittances .... .......... 26 2.9 Shipment and Transportation Services ............ 27 2.10 Tourism Services ................................ 28 2.11 External Debt Indicators, 1975-80 .... ........... 29 2.12 Structure and Terms of Borrowing, 1975-80 ....... 30 2.13 Five Year Time Profile Ratio of Medium- and Long-Term External Debt (Disbursed and Outstanding) .................................. 32 Chapter III 3.1 Actual and Target Growth Rates by Sector, 1971-80 ............................ 36 3.2 Growth of Raw Material and Processing Subsectors in Priority Industrial Sectors .... ............ 37 3.3 Ratio of Direct Imports of Intermediate Inputs to Gross Domestic Output Production ........... 38 3.4 Indicators of the Overall Investment Effort, 1971-80 ....................................... 41 3.5 Functional Distribution of Real Investment Expenditures, 1971-80 ......................... 42 3.6 Incremental Capital-Output Ratios, 1971-80 ...... 44 3.7 Indicators of Aggregate Saving Performance, 1971-79 ....................................... 48 3.8 Household Saving Rates (1971-80) .... ............ 49 3.9 Saving Behavior of Social Sector Enterprise, 1971-80 ....................................... 50 3.10 Distribution of Value-Added of Social Sector Enterprises in the Productive Sector .......... 52 3.11 Indicators of Social Sector Enterprise Saving Behavior ............................... 53  - vi - List of Text Tables (Continued) Table No. Page No. Chapter IV 4.1 Price Trends in Yugoslav Industry, 1970-79 ...... 56 4.2 Indicators of Relative Market Profitability Across Sectors, 1976-80 .57 4.3 A Comparison of Market and Economic Profitability Rates Across Sectors in 1980 .... .............. 60 4.4 Imports by Import Regime, 1971-80 .... ........... 69 4.5 Ratio of Imports to Supply Available for Domestic Use, 1972-79 ..... .................... 70 4.6 Indicators of Import Elasticity, 1971-1980 ...... 71 4.7 Average Quantity Rationing and Foreign Exchange Premium Rates, 1976-80 .74 4.8 Rental Income From Foreign Exchange Rationing as a Percentage of Sectoral Value Added, 1976-80 76 4.9 Estimated Average Export Subsidy Rate, 1976-80 79 4.10 Estimated Sectoral Domestic Resource Costs, 1980 .81 4.11 Exchange Rates and Indices of External Competitiveness .86 4.12 Actual and Market Clearing Exchange Rates, 1976-80 .89 4.13 Alternative Estimates of Market Clearing Exchange Rates, 1980 ...... .................... 91 Chapter V 5.1 Major Targets of the 1981-85 Federal Plan ....... 106 5.2 Projected Growth of Macroeconomic Aggregates, 1981-85 .109 5.3 Foreign Exchange Rationing Under Alternative Scenarios .110 5.4 Historical and Projected Sources of Changes in Demand for Manufacturing Output, Selected Periods .112 5.5 Sources of Change in Demand for Manufactured Output, Selected Countries and Periods .114 5.6 Projected Growth Rates of Output in the Manufacturing Sector, 1981-85 .115 5.7 Capital Account Projections, 1981-85 .... ........ 116  - vii - List of Text Tables (Continued) Table No. Page No. Chapter VI 6.1 Structure and Growth of Industrial Production 121 6.2 Industrial Sector--Growth and Structure Southern European Selected Countries ......... 121 6.3 Industrial Sector Performance, 1976-1980 ....... 122 6.4 Structure and Growth of Industrial Investment in Fixed Assets .............................. 123 6.5 Development of Basic Raw Materials .... ......... 124 6.6 Industrial Employment ...... .................... 125 6.7 Structure and Growth of Industrial Imports, 1975-80 .126 6.8 Structure and Growth of Industrial Exports, 1975-80 ............ .......................... 127 6.9 Plan Targets in Industry ..... .................. 129 6.10 Plan Output Targets in the Industrial Sector ... 129 6.11 Planned Investments in Priority Sectors ........ 131 6.12 Plan Projections of External Trade .... ......... 133 6.13 Supply and Demand Projections for Finished Steel Products .135 6.14 Nonferrous Metals: Existing and Planned Capacities ................................... 138 6.15 Plan Targets in the Chemicals Sector .... ....... 140 6.16 Plan Projections for Main Chemical Product Groups .......... ............................. 141 6.17 Plan Targets for Metalworking Industries ....... 143 Chapter VII 7.1 Percentage Share of Agriculture and Industry in Social Product ...... ....................... 161 7.2 Agricultural Performance, 1971-1980 .... ........ 162 7.3 Fertilizer Consumption - Active Substance, 1976-1980 ............ ......................... 165 7.4 Livestock Investment Efficiency .... ............ 166 7.5 Planned and Actual Investment in Agriculture and Agroindustries 1976-1980 .166 7.6 Growth Rates for Major Agricultural Products, 1981-85 .171 7.7 British Standard Labor Requirements for Yugoslav Private Agriculture, 1980 ..... ................ 175 7.8 Trade Targets of 1981-85 Plan ..... ............. 175  - viii - List of Text Tables (Continued) Table No. Page No. Chapter VIII 8.1 Employment and Labor Force, 1970-75 .... ........ 182 8.2 Social Sector Employment 1971-75, and Plan Targets 1976-80 .185 8.3 Growth of Social Sector Output and Employment by Sector 1971-75, 1976-80 .188 8.4 Rates of Growth of Employment, Captial Stock and Capital Intensity of Production, 1971-79 190 8.5 Growth of Labor Productivity and Real Personal Incomes Per Worker 1971-80 .192 8.6 Employment Trends in Private Sector Agriculture 1971-80 .197 8.7 Distribution of Households by Economic Activity and Income Per Active Family Member 1973 and 1978 ............ .............................. 202 8.8 Some Indicators of Unemployment 1975-80 ........ 204 8.9 Structure of Registered Job Seekers 1970-80 206 8.10 Employment and Labor Force, 1975-80 .... ........ 209 8.11 Labor Force Flows 1970-80 ..... ................. 211 8.12 Share of Social Sector Employment in Total Labor Force by Region 1975 and 1980 .213 8.13 Selected Regional Employment Indicators, 1975 and 1980 ......... ............................. 214 8.14 Regional Demographic Trends, 1961-81 .... ....... 216 8.15 Absorption of the Natural Increase in the Labor Force, 1976-80 .217 8.16 External Migrants by Region of Origin, 1971 and 1981 .219 8.17 Incomes of Social Sector Employees by Region, Selected Years, 1965-79 .223 8.18 Anticipated Changes in the Structure of the Labor Force, 1981-85 .225 8.19 Plan Targets for Social Sector Output, Employment, Labor Productivity and Personal Incomes, 1981-85 ..... ................ 238 8.20 Regional Employment Growth Targets 1981-85 230  - ix - List of Text Tables (continued) Table No. Page No. Chapter IX 9.1 Regional Trends in Output, Population and Per Capita Output 1952-65, 1965-68 .235 9.2 Regional Disparities in Income Per Capita, 1954-80 .237 9.3 Household Income Per Capita Differentials, 1978 238 9.4 Demographic Indicators, 1950-78 .240 9.5 Scale of Interregional Transfers, 1980 .243 9.6 Contribution of Federal Fund to Investment in Less Developed Regions, 1976-80 .245 9.7 Some Basic Indicators of Regional Social Sector Productivity in 1978 .247 9.8 Sources of Social Sector Growth for Major Sectors, by Less Developed Region, 1965-78 251 9.9 Percentage Distribution of Social Sector Value- Added According to Relative Levels of Technical Efficiency by Region (1965-1978) .254 9.10 Financial Results of LDR Social Sector Enterprises, 1980 .264 9.11 Regional Variations in Tax Policy, 1979 .269 9.12 Regional Labor Costs in the Social Sector, 1980 277 List of Charts 1 Bosnia-Herzegovina Potential and Actual Social Sector Social Product (Value-Added), 1965-68 257 2 Kosovo Potential and Actual Social Sector Social Product (Value-Added), 1965-78 .258 3 Macedonia Potential and Actual Social Sector Social Product (Value-Added), 1965-68 .259 4 Montenegro Potential and Actual Social Sector Social Product (Value-Added), 1965-68 .260  COUNTRY DATA - YUGOSLAVIA AREA POPULATION DENSITY 255,804 sq. km. 22.3 million (mid-1980) 86 persons per sq. km. Rate of Growth: 0.9% (from 1970 to 1980) 154 persons per sq. km. of agricultural land POPULATION CHARACTERISTICS (1980) HEALTH (1979) Crude Birth Rate (per 1,000) 16.9 Population per physician 1,795 Crude Death Rate (per 1,000) 8.8 Population per hospital bed 167 Infant Mortality (per 1,000 live births) 32.6 INCOME DISTRIBUTION (1978) DISTRIBUTION OF LAND OWNERSHIP (1971) % snare of household income, lowest quintile 6.6 % owned by top 10% of owners highest quintile 38.7 (social sector Kombinats) 15.1 % owned by smallest 10% of owners (private smallholders) 84.9 ACCESS TO PIPED WATER (1978) ACCESS TO ELECTRICITY Dwellings with piped water (%) 40.5 2 of all dwellings (1978) 89.0 rural (1971) 80.0 NUTRITIUN (1977) EDUCATION Per capita Calorie Supply 3,445 Adult Literacy rate (%) 85 (1975) (13c7 of requirement) Primary school enrollment (%) 100 (1977) Per capita protein supply (grams/day) 101 Secondary school enrollment (%) 79 (1977) GNP PER CAPITA IN 1981 1/: US$2790 GROSS DOMESTIt PRODUCT IN 1981 AVERAGE ANNUAL RATES OF GROWTH (%, constant prices) US S Mln. % 1970-75 1975-80 1981 GDP at Market Prices 69,617 100.0 6.5 5.8 2.2 Total Consumption 45,651 65.6 6.9 5.4 -1.0 Gross Domestic Investment 25,427 36.5 5.5 5.4 1.3 Gross National Savings 24,677 35.4 6.2 5.0 -12.2 Exports of Goods and Nonfactor 6.7 5.3 10.9 Services 16,354 23.5 6.7 3.2 -3.0 Imports of Goods and Nonfactor Services 17,816 25.6 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1980 GDP at Current Factor Cost (1980) Labor Force 4/ Value Added Per Active Resident Worker USt Mn. % Mln. % US$ (1980) %_ Agriculture 2/ 8,516 13.7 2.50 30.6 3,261 43.2 lndustry 3/ 28,801 46.2 2.80 34.3 10,593 140.4 Other 24,993 40.1 2.87 35.1 8,309 110.1 Total 62,310 100.0 8.17 100.0 7,547 100.0 GOVERNMENT FINANCE, consolidated, 1980 US$ Mln. Consolidated Public Sector Receipts 23,588 Expenditures 24,018 Surplus -430 Ratio of Current Receipts to GDP at Market Prices (%) 34.1 MONEY, CREDIT AND PRICES (in billions of dinars) 1976 1977 1978 1979 1980 1981 Money Supply 5/ (end-year position) 206.4 251.1 315.3 375.2 461.6 584.3 Money Supply as % of GDP at market prices 30.4 30.1 30.9 29.2 26.7 24.7 Bank Credit lotal 6/ 569.1 699.3 959.2 1,217.7 1,568.3 1,927.8 Enterprises 440.4 535.8 728.7 943.0 1,225.1 - Government and other Social Sector 78.2 98.4 140.2 157.6 186.5 Households 50.5 65.1 90.3 117.1 156.7 Price Indices (Annual Percentage Change) Industrial Producer Prices 6 10 9 14 27 45 Agricultural Producer Prices 14 11 13 25 36 54 Retail Prices 10 13 14 22 30 47 1/ The per capita GNP estimate is at market prices, calculated by the same conversion technique as the World Bank Atlas. All other conversions to dollars in these tables are at the prevailing period average exchange rate. 2/ Includes irrigation and forestry. 3/ Manufacturing, mining, construction, electricity, gas and water. 4/ Total active resident labor force, excluding unemployed. 5/ Currency in circulation, demand deposits and float. 6/ Short- and long-term credits.  BALANCE OF PAYMENTS, MERCHANDISE TRADE AND DEBT Annual Data at Current Prices 1/ (us$ Millions) 1976 1977 1978 1979 1980 1981 SUMMARY OF BALANCE OF PAYMENTS EXTERNAL DEBT, December 31, 1980 Exports (f.o.b.) 4,878 5,254 5,671 6,794 8,978 10,929 USl Millions Imports (c.i.f.) -7,367 -9,634 29,988 -14_019 -15,064 -15,757 Trade Balance -2,489 -4,380 -4,317 -7,225 -6,086 -4,828 Debt Outstanding and Disbursed 15,435 Official (4,541) Nonfactor Service Receipts 2,051 2,216 2,380 3,771 4,547 5,425 Private (10,894) Nonfact-r Service Payments -88 -888 -1,051 -1,624 -1,565 -2,059 Nonfactor Services Net Balance 1,163 1,328 1,329 2,147 2,982 3,366 Debt Service Ratio 3/ (2) 19.0 Factor Services & Transfers Receipts 1,974 2,640 3,120 3,581 4,247 5,927 Factor Services & Transfers Payments -638 -1,135 -1,775 -2,504 -3,792 -5,215 Factor Services & Transfers Net Balance 1,136 1,505 1,345 1,077 455 712 Current Accunot Balance 165 -1,582 -1,256 -3,661 -2,291 -750 Medium 6 Long-Term Leans IBRD LENDING, (as of September 30, 1981) (Millie, US*) Disbursements 2,320 2,665 3,150 3,200 3,802 2,790 Ameortiation -930 -992 -1,326 -1,704 -1,699 1,807 Ousttanding & Disbursed 2,154.7 Net Disbursements 1,390 1,673 1,824 1,496 2,103 983 Undisbursed 894.5 Export Credits Extended (net) -100 -213 -105 -150 -215 -234 Capital Transactions n.e.i. 2/ -277 172 -204 1,173 553 238 Uee of Reserves -1,178 -50 -259 1,142 -150 -237 MERCHANDISE TRADE Imports Capital Goode 1,759 2,436 2,559 3,572 2,939 2,877 Intermediate Goods 4,697 5,989 6,325 8,935 10,630 11,987 Consumer Goods 911 1,208 1,099 1,512 1,496 893 Total Merchandise Imports (c.i.f.) 3,367 9,633 9,983 14,019 15,065 15,757 Exports Caputal Goods 826 1,080 1,129 1,156 1,362 1,736 Intermediate Goods 2,589 2,667 2,809 3,627 4,581 5,361 Cosu.mer Goods 1,463 1,509 1,730 2,011 3,035 3,832 Total Merchandise Exports (f.o.b.) 4,878 5,256 5,668 6,794 8,978 10,929 MERCHANDISE TRADE INDICES 1976=100 Index of Export Dollar Unit Values IOO 112 123 141 168 181 Index of Import Dollar Unit Values 100 114 120 143 171 188 Terms of Trade Index 100 98 103 99 98 97 RATE OF EXCHANGE Annual Averages US11.00 = Dinar 18.19 18.30 18.64 19.0 24.91 35.51 Dinac = USS0.055 0.055 0.054 0.053 0.040 0.028 1/ Valued at statistical exchange rates. 2/ lncludes errors and omissions, short-term loans, IMF account, and bilateral balances. 3/ Medium- -ad long-term debt soerice as a percentage of gross ourrent account receipts.  YUGOSLAVIA: ADJUSTMENT POLICIES AND DEVELOPMENT PERSPECTIVES THE MAIN REPORT INTRODUCTION 0.01 By any standards Yugoslavia's performance since World War II has been extremely impressive. In this period a largely rural, peasant economy, shattered by war, has been transformed into a modern urban industrial society with the abolition of absolute poverty and of hunger. This has been achieved despite the difficulties of nation-building in a multinational state with wide inheritea regional disparities, while evolving a system of economic management unique to the country. Past World Bank reports have provided an extensive review of Yugoslavia's development achievements and of the economic institutions fashioned by it over this period; for this reason, this account is not repeated here. 1/ Notwithstanding this highly successful performance turbulence in the international economy in the 1970s confronted the Yugoslav economy with a new set of challenges, as the economy was obliged to adjust to such developments as worsened terms of trade, higher energy prices, recession in the industrial countries, shifts in international sources of capital and diminished prospects for employment of Yugoslavs abroad. This report uses the occasion of the start of the 1981-85 Yugoslav plan to review the performance of Yugoslavia in responding to these challenges, while maintaining the pace of structural change. The report is written at a time of unusual strain for the Yugoslav economy, when many of the institutions and instruments of economic management are being critically reviewed within Yugoslavia. The report attempts to make a contribution to this debate. At the same time it should be recognized that policies, targets and institutions are currently in considerable flux, so that elements of this report could be soon overtaken by events. 0.02 This main report is in two parts. The first part deals with issues of adjustment strategy and policy at the economywide level, concentrating especially on the period of the 1976-80 medium-term plan. The second part deals with issues in the major sectors of agriculture and industry, and with issues of employment and regional policy. While the energy sector has been of central importance to Yugoslavia's adjustment efforts, it is discussed only in passing in this report as it is being concurrently studied in an energy sector survey being undertaken by the World Bank in cooperation with the Yugoslav authorities. Major policy suggestions are summarized in Chapter X. 1/ See Yugoslavia: Development with Decentralization (Baltimore: Johns Hopkins University Press, 1975) based upon the findings of a World Bank economic mission which visited Yugoslavia in 1972, and Martin Schrenk, Cyrus Ardalan and Nawal A. El-Tatawy, Yugoslavia: Self-Management Socialism - Challenges of Development (Baltimore: Johns Hopkins Press, 1979) based upon a World Bank mission which visited Yugoslavia in November 1976.  PART I; ADJUSTMENT PERFORMANCE AND POLICIES I. THE ADJUSTMENT STRATEGY OF THE 1976-80 PLAN A. Background to the Plan 1.01 Yugoslavia entered the 1976-80 plan period in difficult economic circumstances. These were partly caused by a series of adverse external shocks over the 1974-76 period, and in part reflected longer-term structural tendencies which had been in evidence at least since the economic reforms of the 1965-67 period. In addition the 1976-80 plan was ushered in at a time of substantial change in Yugoslav economic and political institutions. In order to understand both the adjustment strategy of the 1976-80 plan and its subsequent implementation it is useful briefly to review economic and institutional trends in the period that preceded it. Institutional Change 1.02 The Yugoslav constitution of 1963 and a series of economic measures taken between 1964 and 1967 (usually referred to as the economic retorms of 1965) marked a decisive change from earlier Yugoslav systems of economic management. The content of these reforms has been extensively described and commented upon elsewhere 1/ and does not bear detailed recounting here. In brief, though, these measures instituted two concurrent processes: a reduction in the role of the state in economic management ('de-etatization') and a devolution of remaining state involvement from higher-level to lower-level state agencies (decentralization). These processes involved, among other things, the abandonment of centralized investment allocation in favor of autonomous decision taking by commercial banks, the replacement of mandatory plans by a system of indicative planning, consioerable devolution of fiscal authority away from the federal level and an increasea role for the price system and the market in resource allocation. 1.03 In its actual workings, the "economic model" of 1965 soon aisplayed certain weaknesses. The devolution of authority over public expenditure and investment decisions deprived federal institutions of the most powerful instruments previously utilized by them to direct resources into areas of social priority. While this role was in theory to have been assumed by market forces, in practice the operation of the market was severely abridged. The mobility of investable funds through the banking system was limited and highly regionalized. The more powerful enterprises were able to preempt investment resources, and the financial accountability of enterprises remained limited. Additional distortions were created by the fact that certain prices remained administratively determined while others were liberalized. As a consequence of these shortcomings certain negative trenas in the economy became of growing concern to Yugoslav policy makers in the late 1960s and early 1970s. These included the emergence of considerable 1/ Ibid.  overt inflation, adverse balance of payments trends, and a decline in the efficiency of investment. In addition, there was concern that the system aftorded too much power to the managerial structures of the society, and thereby weakenea the social and ethical goals of self-management. 1.04 Growing awareness of these difficulties, together with other political imperatives, led to further evolution in the system of economic management. The first steps in this direction were amendments to the constitution in 1971. These were followed by a new constitution in 1974 which encompassed these changes, introduced others, and prepared the way for major revisions in economic organizations and institutions. Although the motivations and consequences of the 1974 constitution clearly transcended economic issues, a number of the changes were intended as a response to unresolved issues of economic management, and to perceived weaknesses of a 'pure' market system. 1.05 The 1974 constitution attempted to reconcile decentralized decision making with the need for coordinated national action through the aevelopment of new procedures, particularly in the area of investment planning. While these procedures admitted the role of the market, this was in a more restricted form than previously and attempts were made to make the operations of the market more consistent with socialism and self-manage- ment. 1/ The new system of planning -- self-management planning -- established procedures for obligatory exchange of information between major agents in the economy (essentially social sector enterprises, financial institutions and government bodies) in an attempt to develop an internally consistent set of investment expenditure and financing plans. The new law on planning of 1976 (which further elaborated the provisions of the constitution) further distinguished between priority and nonpriority activities. Decisions on activities to be accorded priority status were to be arrived at consensually at an early stage in the planning process. In the case of priority activities, consistency of plans by a prescribed date was to be mandatory and implementation of these plans obligatory. The same was not required of plans in the nonpriority sector. 2/ 1.06 The new planning law was only one of a series of legislative measures (mostly passed in the 1974-78 period), designed to bring economic relations in all spheres into harmony with the precepts of the new constitution. As the principles and content of the new legislation have been extensively reviewed in the earlier World Bank study 3/ that discussion is not repeated in this report. However two aspects of the new institutional arrangements merit mention: the internal organization of enterprises, and the provision of nonmarketed services. 1/ See Schrenk et. al., p. 67. 2/ The system of investment planning is described more fully in Chapter IV. 3/ Schrenk, et. al.  - 3 - 1.07 In an effort to reassert genuine democracy in the workplace, enterprises were reorganized into Basic Organizations of Associated Labor (BOALs). These were to be the smallest operating units which produced a marketed or marketable output. The enterprise (or Complex Organization of Associatea Labor (COAL)) was no more than conceived to be a voluntary association of BOALs, linked together through contractual relations by mutual self-interest. In principle, BOALs were given the right to calve off from the COAL at any future date, subject to conditions agreed upon at the time of association. Detailed regulations were drawn up to govern the calculation of income, its distribution between BOALs, and within BOALs between saving (accumulation) and personal income. In the case of social welfare and other nonmarket services (including such functions as education and health) new organizations called communities of interest (COI) were formed at the republican and local level, to provide these services in their respective Jurisdictions. Policy for these bodies was set at the local level and they were to be financed through local levies and contributions. Economic Trends 1.08 The period following the 1965 reform witnessed a substantial shift in the structure of Yugoslavia's balance of payments. As Table 1.1 indicates, between 1965 and 1971 there was a substantial increase in the aeficit on merchandise trade, 1/ from about 3% of GDP to almost 10% of GDP. Merchandise exports and merchandise imports contributed roughly equally to this increase in the merchandise trade deficit, although at different times. Between 1965 and 1968 the share of merchandise exports in GDP dropped by four percentage points, but this was partially compensated for by a reduction in the merchandise import ratio. Thereafter the export share stabilized and the import share began to rise, until in 1971 merchandise imports were 22% of GDP. 1.09 As a consequence of these developments there was a sharp decline in the ratio of merchandise exports to merchandise imports, from about 85% in 1965 to 56% in 1971. This trade deficit was offset to some degree by a rising surplus on both nonfactor services and factor services and transfers, the latter item reflecting the growth of workers' remittances which became an important element in the balance of payments after 1965. Despite this offset however, open current account deficits began to emerge; while these were at manageable levels until 1968, the resumption of more rapid growth thereafter precipitated a balance of payments crisis in 1970 and 1971. A package of stabilization measures, which included two devaluations of the dinar, was introduced in 1971. Through adjustment in both exports and imports, and with continued buoyancy in remittances, the situation was turned around in 1972 ana a substantial current account surplus of $419 million, equivalent to 2.2% of GDP, was recorded. Slow growth policies were continued in 1973, leading to another surplus, again assisted by a strong performance in remittances. 1/ Unless otherwise indicated, and following Yugoslav practice, the terms "imports" and "exports" in this report refer to trade in goods and nonfactor services, while "merchandise imports" and "merchandise exports' refer to visible trade.  Table 1.1: EXTERNAL SECTOR DEVELOPMENTS, 1965-80 (ratios to current price GDP, in percent) 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 Exports A. Goods 16.3 14.3 13.3 12.3 12.5 12.2 12.3 14.1 14.0 14.2 13.2 13.1 11.5 10.4 10.0 12.9 15.7 B. Nonfactor Services 5.4 5.4 5.5 5.7 6.1 6.3 6.9 8.1 7.8 7.3 6.4 5.5 4.9 4.3 5.6 6.6 7.8 C. Goods and Nonfactor Services 21.7 19.7 18.8 18.0 18.6 18.5 19.2 22.3 21.8 21.5 19.6 18.6 16.4 14.7 15.6 19.5 23.5 Imports D. Goods 19.2 18.5 18.1 17.4 18.1 20.9 22.1 20.5 22.2 28.1 24.9 19.7 21.1 18.2 20.7 21.7 22.6 E. Nonfactor Services 2.2 2.2 2.2 2.1 2.2 2.6 3.5 3.7 3.2 3.1 2.2 2.4 1.9 1.9 2.4 2.3 3.0 F. Goods and Nonfactor Services 21.4 20.7 20.3 19.5 20.3 23.5 25.6 24.2 25.4 31.2 27.1 22.1 23.0 20.1 23.1 24.0 25.6 G. Net Factor Income and Current Tranfers from Abroad outflow) -0.3 0.6 0.2 0.4 1.0 2.4 3.5 4.6 6.0 5.3 4.3 4.0 3.2 3.2 2.1 1.2 1.0 H. Balance of Merchandise Trade (A - D) -2.9 -4.2 -4.8 -5.1 -5.6 -8.7 -9.8 -6.3 -8.1 -13.9 -11.7 -6.7 -9.6 -7.9 -10.7 -8.8 -6.9 1. Resource Gap (C - F) 0.3 -1.0 -1.5 -1.5 -1.7 -5.0 -6.3 -2.0 -3.6 -9.7 -7.6 -3.6 -6.7 -5.5 -7.5 -4.5 -2.1 J. Current Account Balance (G + I) 0.0 -0.4 -1.3 -1.1 -0.7 -2.6 -2.4 2.7 2.4 -4.4 -3.2 0.4 -3.5 -2.3 -5.4 -3.3 -1.1 Memo: Percentage Growth in GDP (Constant 1972 prices) 1.4 5.0 3.3 5.8 11.2 5.0 8.8 3.6 2.6 14.7 0.9 5.3 8.5 8.5 4.2 2.4 2.2 Percentage Change in Terms of Trade 1.9 2.8 0.0 -2.7 -1.0 1.9 1.0 -0.2 -0.7 -6.0 1.9 0.5 -0.7 3.4 -2.5 -0.5 -1.3 Current Account Balance ($ mn.) 73 -33 -82 -106 -110 -340 -357 419 485 -1,183 -1,003 165 -1,582 -1,256 -3,661 -2,291 -750 1/ Trade values taken from dollar balance of payments data, converted at period average exchange rates. Source: Statistical Appendix Tables A 2.1, A 3.1, A 3.2; Statistical Yearbook, 1981, Table 102.27; World Bank Report No. 2972-YU, Export Performance and Prices, October 16, 1980, Table A.l.  - 5 - 1.10 Following the success of this stabilization episode, macroeconomic policy became more expansionary in 1974, and growth proceeded extremely rapidly. However the timing of the boom coincided with the increase in oil prices and the recession in the industrial market economies. These developments had a substantial effect on Yugoslavia's terms of trade and on the growth of principal markets for Yugoslavia's exports, and checked the growth in workers' remittances. There was consequently a further large increase in the merchandise import ratio (in nominal terms) with equivalent increases in the trade gap and the current account deficit. Another stabilization effort had to be mounted, yet again sharply curtailing growth, and restricting the growth of import volumes. 1.11 By the beginning of the 1976-80 plan therefore a stop-go pattern of growth had become an established feature of Yugoslav economic performance. The repetitive nature of these cycles had led Yugoslav economists to refer to them as the 'trade scissors' cycles of domestic economic growth. 1/ The beginning of each such cycle was marked by a signiticant expansion of exports and a sharp increase in the ratio of export growth to import growth. As domestic economic growth picked up, import growth quickened ana export growth declined, reducing the ratio to a critical point that marked the turning point of the cycle. At this point economic growth rates began to fall as a consequence of foreign exchange shortages that interrupted the flow of imported inputs, and as a result of policies designed to slow the economy. This slowdown generated a growtb in exports and a reduction in imports which permitted policy to become more expansionary, and growth to resume. Underlying this cyclical pattern was the shift in the structure of the balance of payments that had occurred. This structure consisted of a large deficit in merchandise trade, about 12% of GDP, covered by a relatively predictable surplus on nonfactor services and a substantial but uncertain surplus on factor service account. This was rightly regarded by the Yugoslav authorities as a weak structure, and one likely to constrain growth in the future. Accordingly improvement in the external sector was highlighted as a major structural objective of the 1976-80 Federal plan. 1/ The concept of 'trade scissors cycles' was first introduced by Horvat in his book on business cycles. See Branko Horvat, Business Cycles in Yugoslavia, International Arts and Science Press, 1971. More recently, a consortium of Yugoslav economists has demonstrated the continued relevance of this concept to the cyclical fluctuations of the 1970s. See Mladjen Kovacevic, Ljubomir Madzar, Zvonimir Marovic, Sofija Popov, Zoran Popov, Davor Savin and Nikola Zelic, "Basic Determinants of and Conditions for Dynamic Development and Balanced Economic Trends in the 1981-85 Period," Institute of Economic Sciences, Belgrade, 1980.  - 6 - B. The Adjustment Strategy 1.12 The 1976-80 plan envisaged external adjustment occuring through a combination of export promotion and import substitution, while maintaining high growth rates of output, investment and employment. The major foreign trace and output targets of the plan are presented in Table 1.2. It is clear from this table that, by the standards of the past, the plan's adjustment strategy was heavily weighted toward import substitution. The plan called for 8% growth in exports. This was in fact slightly lower than the actual rate of 8.4% realised in the 1971-75 period and did not seem to imply any raaical shift in course. On the other hand the projected growth in imports of 4.5% did represent a substantial break with the past. When taken in conjunction with the target growth rate of 7% in gross material product (GMP) this import target implied an aggregate elasticity of 0.5, well below either the actual level of 1.5 in the 1971-75 period or the longer-term level of around 1.1 recorded in the 1960s. 1/ Table 1.2: EXTERNAL SECTOR TARGETS OF THE 1976-80 PLAN Actuals 1/ Plan 1971-75 1976-80 Real Growth Rates (%) Gross Material Product 5.9 7.0 Exports (Goods and Nonfactor Services) 8.4 8.0 Imports (Goods and Nonfactor Services) 8.8 4.5 Fixed Capital Formation 7.1 8.0 Elasticities (wrt GMP) Exports (GNFS) 1.4 1.1 Imports (GNFS) 1.5 0.6 1/ Figures are calculated point-to-point. As such they differ from data presented in Schrenk, et. al. which are calculated from three year averages. Source; Schrenk, et. al., Table 9.17; Statistical Appendix Tables A.3.1 and A.3.2; material provided by the Yugoslav authorities. 1/ See Schrenk et. al., Tables 9.8 and 9.17.  - 7 - 1.13 The choice of an adjustment path heavily slanted toward import substitution was influenced by several perceptions. There was, firstly, concern at the rapid increase in the economy's import dependence following the post-1965 liberalization. A rise in import dependence over this period was consistent with the principal objective of the 1965 reforms: opening the Yugoslav economy to external trade, and aligning the productive structure more closely with international comparative advantage. However, Yugoslav policymakers were also influenced by a long-standing and widely-held belief, that internal price controls, coupled with the structure of protection had resulted in a distorted pattern of relative prices domestically. As a result of these purported distortions, production in many raw material and basic industries was thought to have lagged behind levels that were economically rational, even for an economy more responsive to international cost patterns. Concern over increased dependence on intermediate imports was aggravated by world trends in energy prices and the growing burden of payments for imported oil in the total import bill. Changes in world energy prices were thought to warrant a substantial effort to develop domestic energy resources, and to restructure domestic plant and equipment in order to reduce dependence on foreign oil. At the same time the boom in international commodity prices in the early 1970s provided added incentive to development of Yugoslavia's mineral resources. 1.14 These arguments in favor of economically efficient import substitution were coupled with some pessimism on the prospects for growth in exports much above the historical trend rate. It was felt that export possibilities were limited by high technology competition and protectionist barriers in the developed market economies, and by low wage competition in labor intensive products from lesser developed countries. Equally, the oscillations in prices and output in the international economy of the early seventies had buffeted Yugoslavia along with other developing countries, and an import substituting strategy was seen as offering a more certain path to external balance, while making the economy less vulnerable to external shocks. Adding support to this export pessimism were developments at the time of preparation of the plan, including the growth of barriers against Yugoslav agricultural exports by the EEC in 1974 and the recession in the developed market economies at that time. It should be noted that Yugoslavia was not alone in choosing an import substitution strategy as the dominant mode of adjustment to the external shocks of the 1974-78 period: this was the dominant tendency among the semi-industrial developing countries. 1/ 1.15 In general support of these aggregate import substitution goals, but more specifically to address the structural imbalances that were perceived to exist in the domestic productive structure, the 1976-1980 plan called for an ambitious restructuring of the economy. This was to be achieved through a substantial investment effort consciously directed at 1/ See World Development Report, 1981, Chapter VI.  - 8 - designated priority sectors. These priority sectors were to receive preferential access to investment funds in order to permit them to grow more rapioly than the rest of the economy. The priority sectors were: electrical energy, coal extraction, oil and gas extraction and refining, ferrous metals, nonferrous metals, manufacture of basic chemicals, extraction of nonmetallic minerals, machinery and shipbuilding, agroindustry, highway transportation and foreign tourism. 1.16 Investment in fixed assets was planned to grow at 8% a year over the plan period, up from an already substantial growth rate of 7.1% between 1971 and 1975. Of this investment 61% was to occur in the so-called leconomic' sectors; the remainder in the noneconomic sectors 11. The aim of the priority allocation mechanism was to influence the distribution of this economic fixed investment between branches. As the data in Table 1.3 indi- cate, the share of priority sectors was slated to increase from 53.3% of total economic investment to 64.6% in the 1976-80 period. These figures attest to the magnitude of the restructuring of investment foreseen in the plan. As the table indicates, the major shifts envisaged were in the electric power, oil and gas and chemicals sectors, with continued priority accorded to highway transportation. The investment strategy was thus clearly cesigned to strengthen the raw material and infrastructure base of the economy. By contrast, with the exception of the machinery and shipbuilding sectors, there appears to have been little attention paid to the creation of capacities explicitly for export. 1/ Yugoslav statistical conventions economic and social activity into the 'economic' and 'noneconomic' sphere, where the 'economic' sphere covers the production of goods and services for commercial purposes, and the 'noneconomic' sphere covers such social services as education, health, housing and administration. For national income accounting, Yugoslavia follows a somewhat different classification scheme. In line with Marxian concepts, income is considered to be generated only by 'productive' activities. These include all economic sectors which proauce goods, but only a portion of the economic sectors which produce services, together with a portion of the noneconomic sectors which generate services of use in national production. Output from economic activities is included in the Yugoslav measure of national output, gross material product (GMP; sometimes referred to as gross social product (GSP)). The principal nonproductive branches are health, education, administration, defense, banking and housing. GNP and GDP figures in this report have been estimated by the World Bank on the basis of Yugoslav data on GMP, and additional statistical information on the service sectors excluded from GMP. For additional details please see Appendix IV, Volume III.  - 9 - Table 1.3: STRUCTURE OF INVESTMENT IN FIXED ASSETS IN ECONOMIC SECTORS, 1971-75 and 1976-80 (in percent; underlying data based on constant price estimates, 1975=100) 1976-80 1971-75 (actual) 1976-80 Plan (Estimate) All Priority Sectors 53.3 64.6 59.5 of which: Electrical Energy 9.4 12.1 14.9 Coal Extraction 1.3 1.8 2.0 Oil & Gas Extraction 1.8 6.1 4.8 & Refining Ferrous Metals 3.2 3.6 3.3 Nonferrous Metals 3.2 3.6 4.2 Manufacture of Basic 1.8 4.6 3.6 Chemicals Extraction of Nonmetallic 0.3 1.1 0.7 Minerals Machinery & Shipbuilding 4.0 2.8 4.3 Agroindustry 9.9 11.0 9.2 Highway Transportation 14.4 14.2 10.1 Foreign Tourism 4.0 3.7 2.4 Nonpriority Sectors 46.7 35.4 40.5 Total Fixea Investment (Productive Sectors) 100.0 100.0 100.0 Source: Data provided by the Yugoslav authorities. 1.17 The desired acceleration in fixed investment translated itself into a faster growth in aggregate investment over the period, 7.2% instead of 5.3% in the 1971-75 period. Given a target growth rate in gross material product (and by assumption, an equivalent growth in gross domestic product), this implied a virtually unaltered investment share in GDP, of about 29%. The plan documents themselves did not provide an explicit financing pattern for this investment effort in national accounts terms. The 1976 Bank mission did however make estimates of the resource balance implied by the plan's foreign trade targets, and of the net support likely to be available from  - 10 - factor service receipts, particularly net workers' remittances. The results of its analysis are shown in Table 1.4. As can be seen, the domestic and national savings rates implied by the 1976-80 plan on this reckoning were within the limits of past experience. Table 1.4: MACROECONOMIC INDICATORS 1971-75 (Actual) AND 1976-80 (Planned) (as ratios to GDP) 1971-75 1976-80 Gross Investment Rate 29.8 29.2 National Saving Rate 27.6 27.1 Domestic Saving Rate 24.0 24.9 Source: Schrenk, et. al., Table 5.6 1.18 There remainea the further issue of the availability of external capital to finance the gap between gross domestic investment and gross national savings. The external financing requirements for the 1976-80 period were not explicitly articulated in the plan documents reviewed by the 1976 mission. However the plan did establish a cumulative current account deficit of $5.0 billion over the five year period, in nominal terms. Taking into account projected amortization of debt existing at the beginning of 1976 and the neea to maintain adequate reserve cover, this target current account deficit implied gross external borrowing of $9.8 billion over the period. The implied increase in medium- and long-term (MLT) external debt outstanding and disbursed (DOD) over the period was $6.0 billion, as compared to a stock of MLT DOD of $5.8 billion at the end of 1975. On the basis of a similar analysis of capital requirements, the 1976 mission concluded that adequate external financing was likely to be available to Yugoslavia without any significant increase in the debt service ratio.  - ii - Table 1.5; ESTIMATED EXTERNAL FINANCING REQUIREMENTS OF THE 1976-80 PLAN (in billions of US Dollars) Projected Current Account Deficit 5.0 Projected Increase in Reserves 1.0 Scheduled Amortization 3.8 Gross Medium- and Long-Term Borrowing 9.8 Net Increase in Medium- and Long-Term Debt 6.0 Source: World Bank estimates. 1.19 Taken overall, and given the circumstances of the time, the plan represented a credible and consistent scenario for the adjustment needs that the country faced at the end of 1975. The strategy in many respects accorded with the adjustment profile recommended by the World Bank l/ of high investment and savings, and only a temporary interruption in growth. As the Bank has noted, "programs to expand the production of energy and tradeable goods require substantial new investment. /In addition/ a high investment economy is able to "turn over" its old capital stock quickly so as to reflect new scarcities, especially more expensive energy". 2/ Given Yugoslavia's already high savings and investment rate the need for additional savings was perhaps lower than that in other countries. The main criticism that could have been made of the strategy at the time was that it was excessively biased toward import substitution goals. As discussed in detail below, there was already evidence of faltering export performance at the time the plan was being prepared. While the import substitution bias of the plan was both acknowledged and endorsed by the 1976 World Bank mission, it was pointed out that the targeted growth of output and imports projected in the plan were insufficient for the growth in aggregate final demand that was projected. 1.20 The 1976-80 plan was thus explicitly geared toward external adjustment and a conscientious effort was made to translate its strategy into practice. Despite these efforts, by the end of the plan Yugoslavia was suffering its most intense foreign exchange crisis in two decades, accompanied by unprecedented inflation and the prospect of sustained low growth rates for five years in a row. The deterioration in Yugoslav economic performance that became evident in the post-1979 period raises questions about the factors contributing to the crisis. How did Yugoslavia move from a current account surplus of $165 million in 1976 to a deficit of $3.7 billion in four years? Was the crisis the outcome of an inappropriate strategy or of 1/ See World Development Report, 1981, Chapter VI. 2/ Ibid., page 66.  - 12 failures of implementation and policy, as its resemblance to past foreign exchange crises would indicate, or can it be explained by exogenous shocks coming from the world economy? Answers to these questions are not just of interest in themselves but are of importance in assessing the strategy of the 1981-85 plan, and of the policy framework being used to implement it. 1.21 The analysis in Part I of the report addresses these and related questions about the outcome of the 1976-80 plan and the origins of the present crisis, as a prelude to an assessment of the present adjustment strategy. In both the historical and the forward-looking discussions the analysis draws extensively upon the simulations of a computable general equilibrium (CGE) model of Yugoslavia constructed for this report. The model is described in Appendix I. The next two chapters review plan performance in the key areas of the balance of payments, output, investment and growth. Chapter IV reviews the policy environment in the 1976-80 period, particularly as it influenced the allocation and pricing of capital and of foreign exchange, and draws upon this analysis to provide a summary appraisal of the experience of the 1976-80 period. Chapter V provides an assessment of the adjustment strategy of the 1981-85 plan, and of developments which have occurred since the 1981-85 plan was launched.  - 13 - II. PLAN PERFORMANCE: OVERVIEW AND EXTERNAL SECTOR DEVELOPMENTS A. An Overview 2.01 The cyclical relationships between imports, exports and domestic growth characteristic of Yugoslavia in the late sixties and early seventies persisted in the 1976-80 period. Major indicators for the period are provided in Table 2.1. The economy began the period in a trough caused by policy measures designed to ease the foreign exchange crisis of 1974-75. As a result, output growth in 1976 was the lowest realized in Yugoslavia in the postwar period. Depressed domestic conditions, combined with severe restrictions on imports, allowed for a small current account surplus and a reserves buildup. This gave the authorities the confidence to proceed with the more expansive strategy of the five-year plan. 2.02 Growth proceeded rapidly in 1977, powered by a more liberal monetary and import policy. Fixed capital formation grew by 12% after a cutback the previous year, and the real import of goods and nonfactor services rose by 12.2%. In response to the booming domestic economy, export growth slackened significantly; this, combined with fast import growth led again to a large current account deficit, of $1.3 bn., and to an acceleration in inflation. The strength of this expansion was regarded as unsustainable and policy became mildly restrictive in 1978. There was a reduction in both imports and investment expenditures. The overall growth rate declined slightly but remained at the relatively high level of 6.8%. The slowdown in growth did not appreciably affect the inflation rate; nevertheless there was some improvement in the growth rate of exports. 2.03 The boom in the domestic economy survived into 1979. However the combination of rising domestic inflation, deteriorating balance of payments trends and the continuing sluggishness of growth in the OECD area made it increasingly clear that the expansion could not be sustained. Three additional shocks considerably aggravated the situation. These were: a poor harvest in 1978 which created a need for substantial agricultural imports in 1979; an earthquake in Montenegro which adversely affected tourism receipts both in the affected area (and perhaps more widely) and the increase in the price of oil imports, which increased Yugoslavia's expenditure on imported crude oil by about $500 million. 2.04 The combination of these events led to a current account deficit of $3.7 billion in 1979, equivalent to 5.4% of GDP, the largest deficit in relative terms that Yugoslavia had sustained since the mid-sixties (see Table 1.1). A stabilization program was instituted toward the end of 1979 consisting of tight monetary policy and direct controls on investment expenditures, particularly in the noneconomic sector. This program was supported by a standby arrangement with the IMF, concluded in May 1980. In June 1980 the dinar was devalued by 30% against the U.S. dollar in gross terms. 1/ In addition imports were restricted to essential items. 1/ The devaluation coincided with the abolition of a 10% import surcharge, coupled with some reduction in export rebates. As a result the net devaluation was somewhat less than this.  - 14 - Table 2.1: MAIN INDICATORS OF THE 1976-80 PERIOD 1976-80 1976 1977 1978 1979 1980 Actual Plan 1/ Real Growth Rates in Percent (value data deflated to 1972 prices) Gross Material Product 3.9 8.0 6.8 7.0 2.2 5.6 6.9 Social Sector Employment 3.6 4.5 4.5 4.3 3.2 4.0 3.5 Industrial Production 4.0 9.4 8.7 8.3 4.4 6.9 8.0 Agricultural Output 7.0 5.0 -6.0 6.0 -2.0 1.9 3/ 4.0 3/ Exports of Goods and Nonfactor Services 2/ 10.7 -4.4 -0.2 12.6 7.7 5.3 7.8 Merchandise Exports 15.2 -4.2 -1.4 4.4 11.2 5.0 7.0 Imports of Goods and Nonfactor Services 2/ -4.4 12.2 0.6 18.5 -11.1 3.2 4.1 Merchandise Imports -6.9 15.1 0.6 17.3 -10.1 3.0 3.8 Fixed Capital Formation 7.5 11.7 13.4 4.6 -1.5 8.1 7.0 Nominal Growth Rates, in percent Retail Prices 9.4 13.3 13.4 21.9 29.9 17.4 - Millions of Current Dollars Balance of Payments: Current Account (- = Deficit) 165 -1,582 -1,256 -3,661 -2,291 -8,625 -5,000 1/ Target growth rates cited here are based on the actual outturn in 1975, while elsewhere in the text target growth rates are based on estimates of 1975 performance at the time that the 1976-80 plan was prepared. 2/ There are several problems with Yugoslav current price balance of payments data, particularly in the use of "statistical" rather than market exchange rates in aggregating trade denominated in different currencies. In addition, relatively small variations in deflators can make for larger differences in estimated real rates; the real estimates presented above should therefore be treated with some caution. 3/ Base = 1974/5 Average. Source: Statistical Appendix Tables (various) and information provided by the Yugoslav authorities.  - 15 - 2.05 These measures had a substantial effect on both growth and the balance of payments. Growth of material product in 1980 declined to 2.2%, a level lower than that of 1976. Imports were sharply cut while exports grew substantially. As a result the deficit on merchandise trade was reduced by $1.2 billion. This, coupled with a modest increase in the surplus on services led to a substantial improvement in the current account deficit, to $2.3 billion or 3.3% of GDP. The shift of resources to the external sector was made possible by a cut in fixed capital formation. In addition the growth in consumption was sharply curbed primarily through a fall in real wages in the social sector. Despite this drastic slowdown inflation accelerated. In part this reflected the impact on the domestic economy of the increased price of imported energy and the devaluation of the dinar. In addition, however, as analysed below (Chapter VIII), it represented the attempt of enterprises to rebuild their liquidity and savings in the face of restricted credit availability. 2.06 The consequences of these current account developments were felt by the capital account. There was a rapid growth in external debt, both medium- and long-term and short-term. In contrast to the planned increase in medium- and long term debt outstanding and disbursed of $6 billion over the period (cf. para 1.18), the actual increase was $9.6 billion, and the buildup of short-term debt and bilateral payment obligations was over and above this. This growth in debt in turn affected the current account by imposing additional interest payment obligations. As the incremental debt was increasingly on a floating rate basis, Yugoslavia became even more vulnerable to the increase in Eurodollar interest rates which occurred after 1979. Gross interest payments increased from $0.4 billion in 1976 to $1.3 billion in 1980 (Statistical Appendix Table A 3.2). 2.07 Taking the plan overall, in substantial measure Yugoslavia succeeded in achieving its aggregate growth and investment objectives. Yet at the end of the plan its external position was considerably more vulnerable than had been the case at the beginning. As is evident from the above narrative, external shocks were to a considerable degree responsible for this outcome. The remaining sections of this chapter and the next two chapters attempt to assess the extent to which domestic performance and policies could have mitigated the force of these external shocks, and also the degree to which the underlying structural objectives of the plan were fulfilled despite the shocks encountered from the outside world. B. The External Sector Sources of Change in the Current Account Deficit 2.08 Since management of current account deficits was the prime preoccupation of Yugoslav policymakers over the plan, it is of interest to decompose the influences on the current account deficit, both to identify the factors of greatest quantitative significance, and to distinguish between exogenous shocks and elements more within the domain of Yugoslav policies. The analysis of Table 2.2 takes the current account deficit incurred in 1975 (of $1.0 billion) as a benchmark, and compares the current account deficit of each year in the plan with reference to this benchmark.  - 16 - 2.09 Three sets of effects are identified: real factors, price effects and the nominal impact of increased interest payments. In the first block, 'real factors', exports and imports are defined to include all goods and services, other than interest receipts and payments. These flows are valued at 1975 prices to measure changes in real resource transfer as compared to 1975. The contribution of price movements to the deficit is isolated in the second block, which combines the effects of general inflation in traded goods over the period and the effects of terms of trade changes. It should be emphasized that this decomposition is relatively crude, in that it does not attempt to capture important interactions between the individual elements. The impact of price developments on the deficit for Table 2.2: SOURCES OF CHANGE IN CURRENT ACCOUNT DEFICIT, 1975-80 (US$ million) 1976/75 1977/75 1978/75 1979/75 1980/75 Change in Nominal Deficit (over 1975 deficit) 1168 -579 -253 -2658 -1288 A. Real Factors 1/ 880 -599 -591 -1656 -255 Exports (+ = increase) 530 128 476 1218 1526 Imports (- = Increase) 350 -727 -1067 -2874 -1781 B. Price Effects 2/ 292 3 363 -644 -224 C. Interest Payments (net) -4 17 -25 -358 -809 Receipts 28 61 93 126 135 Expenditures -32 -44 -118 -484 -944 1975 1976 1977 1978 1979 1980 Memo; Current Account Balance -1003 165 -1582 -1256 -3661 -2291 1/ Exports and Imports refer to exports and imports of all goods and services with the exception of interest payments. They are deflated by their respective merchandise trade indices. 2/ Residually derived. Source: Statistical Appendix Tables A 3.1, A 3.2, A 3.5 and A 3.6; Mission Estimates  - 17 - example clearly depends upon the size of the underlying real deficit. More complex decomposition schemes which take such interactions more explicitly into account have also been devised. 1/ 2.10 It is evident from this table that roughly two-thirds of the $2.6 billion increase in the current account deficit from $1.0 billion in 1975 to $3.7 billion in 1979 was attributable to 'real' factors, with price factors accounting for a further quarter of the deterioration, and increased interest payments for the remaining one-sixth. By 1980 however, the pattern was significantly different. As a consequence of deep cuts in imports and a successful export drive, the contribution of 'real' factors to the increase in the deficit had been almost wholly eliminated and the increase in the deficit as compared to 1975 was due to price effects and increased interest expenditures, in roughly equal measure. The table thus reveals the 1979 crisis to be the outcome of three interrelated events: a big increase in real imports not matched by exports, thereby widening the trade deficit, adverse price movements which considerably compounded the financial consequences of this widened real deficit, and a sharp increase in interest payments on account both of rising rates of interest, and of the increased borrowing needea to finance the deficit. 2.11 Although price developments, both directly and indirectly (through their impact on the need for additional borrowing and on the nominal level of international interest rates) were an important source of the 1979 crisis, their quantitative impact was as sizeable as it was primarily because of the large real trade deficit in that year. Table 2.3 examines the evolution of this deficit by components, in real terms, using the merchandise deflators for the various components (including services) for comparability with Table 2.2. The growth in the 'real' deficit between 1975 and 1979 is seen to reflect several developments. After a strong spurt in 1976 (a year of domestic recession), export growth slowed across the board in 1977 and 1978, although there were additional secular influences, such as a sharp decline in the exports of the shipbuilding sector, one of the major exporting sectors at the beginning of the plan. The real surplus on nonfactor services stagnated, reflecting both weak demand for tourism and transport services in the early years of the plan, and strong growth in Yugoslav expenditures on transportation services as Yugoslav trade was increasingly carried on ships of foreign registry. Finally, as had been expected, net remittances declined in real terms with the reduction in the overseas work force. 2.12 The syndrome that had characterized the Yugoslav balance of payments in the first half of the 1970s thus persisted into the second half as well. Against the background of sluggish growth in exports, a declining real surplus on workers' remittances, and a stagnating real surplus on nonfactor services, real import growth had to be held in check throughout the period: between 1975 and 1979 merchandise imports grew at 5.7% per year, and declined from 25% to 21% of GDP. The balance of payments was thus 1/ See Bela Balassa, The Newly Industrializing Developing Countries After the Oil Crisis, World Bank Staff Working Paper, No. 437, October 1980 and World Development Report, 1981, Chapter 6.  - 18 - Table 2.3: EVOLUTION OF THE REAL DEFICIT, 1975-80 1/ (in 1975 prices) Average Annual Growth 1975 1976 1977 1978 1979 1980 1976-80 Merchandise Exports 4,072 4,690 4,491 4,430 4,622 5,130 5.0 Merchandise Imports -7,694 -7,155 -8,234 -8,189 -9,602 -8,608 2.9 Trade Balance -3,622 -2,464 -3,743 -3,759 -4,980 -3,478 Nonfactor Service Exports 1,982 1,992 1,894 1,951 2,583 2,598 6.3 Nonfactor Service Imports -695 -862 -759 -862 -1,112 -894 7.0 Nonfactor Service Balance 1,287 1,130 1,135 1,090 1,471 1,704 Workers' Remittances (Inflows) 2,004 1,906 1,801 2,153 2,071 1,856 -1.0 Workers' Remittances (Outflows) 2/ -397 -419 -520 -803 -946 -1,065 22.9 Workers' Remittances Balance 1,607 1,487 1,281 1,351 1,125 791 Balance on Goods, Nonfactor Services and Workers' Remittances -728 152 -1,327 -1,319 -2,384 -983 Memo: Export Price Index 100 104.0 117.0 128.0 147.0 175.0 Import Price Index 100 103.0 117.0 122.0 146.0 175.0 Terms of Trade 100 101.0 100.0 104.9 100.7 100.0 Growth over Previous Year: Merchandise Exports 15.2 -4.2 1.4 4.3 10.9 Merchandise Imports -7.0 15.1 0.5 17.3 -10.4 1/ All receipts deflated by export price index, all outflows by import price index. 2/ Recorded under nonfactor service outflows in 1975. Source: Statistical Appendix Tables A3.1, A3.2, A3.5 and A3.6.  - 19 - at best in a somewhat uneasy balance at the beginning of 1979. The various shocks of 1979 destroyed this balance by simultaneously imposing price shocks, interest rate shocks and an additional need for imports on the economy. The pattern of response, rather as in 1976, was again a reduction in domestic growth and imports and a renewed spurt in exports. This had the effect of eliminating the real deficit that had emerged between 1975 and 1979; the difference between the current account deficit of $2.3 billion in 1980 and $1.0 billion in 1975 thus entirely reflected the effects of inflation in traded goods prices, terms of trade changes and increased interest payments. 2.13 From the above analysis it is clear that Yugoslavia had not been able to reorient its balance of payments by the time that the shocks of 1979 occurred, and that the bulk of the difficulty continued to arise from exports, particularly merchandise exports. In order to understand better the factors which determined Yugoslavia's export performance in this period, a more detailed look is now taken at Yugoslavia's export performance over the longer term. This analysis draws in part on an earlier World Bank report (Yugoslavia: Export Performance and Policies, Report No. 2972-YU). In view of the detailed coverage provided in that report only the major components of the Yugoslav export structure are discussed here. In addition export performance in industry and agriculture are further discussed in Chapters VI and VII. Given the importance of the import regime and structure for the pattern of incentives in the economy, import behavior in the period is discussed later, in Chapter III. Merchandise Exports 2.14 The report cited above documented the fact that Yugoslavia was a strong exporter in the early sixties, with export growth faster than the growth of world trade. However, after 1966 Yugoslavia's export effort entered a period of slower growth and Yugoslavia lost its share of world exports. Concurrent with this slowdown in aggregate exports were significant changes in commodity and market structure. Since the early 1950s diversification of exports by market area has been an explicit objective of Yugoslav policy, with three broad market areas being distinguished: the industrial market economies of the OECD (DCs), the developing countries (LDCs) and the centrally planned economies (CPEs). Tables 2.4 and 2.5 provide information on the market and commodity classification of Yugoslav exports across these trading groups in the 1970s. 1/ 1/ The market categories used in Table 2.4 in general conform to definitions used in the World Bank's World Development Report. In particular, this implies that the countries of Southern Europe are classified as developing countries. Following the Bank's standard taxonomy, the group of oil exporting developing countries includes both members of OPEC and thirteen non-OPEC members. The EEC is defined to include the nine present members consistently through the analysis. For further details please see Report 2972-YU, Annex I. As these data are assembled from partner country sources they do not necessarily match export data from Yugoslav sources presented elsewhere in this report.  Table 2.4) AGGREGATE REGIONAL AND COMMODITY DISTRIBUTION OF EXPORTS 1970, 1975 AND 1979 Exportn (values in million US$) Regional Distribution 1%) C-nweedity Distribution (%) Of Which Centrally Of Which C-ntrally Of wbich Centrally Developed Of bhich Developing Oil Ple.nnd Developed Of ehich Devolopieg Oil Planned ..v.loped Of whicb Developing oil Planned Ceuntrien EEC Countries xp-orting Ecnoemien World Countries EEC Countries Enporting Economies World Countries EEC Countries E.oprtiog Eoon-ies World 1970 Primary 508.6 394.5 63.9 16.4 177.5 750.0 67.8 52.6 8.5 2.2 23.7 100.0 56.8 60.2 26.8 24.0 32.6 44.7 Agriculture 304.4 243.2 38.7 8.6 89.6 431.6 70.5 56.3 9.0 2.0 20.5 100.0 14.0 37.1 16.2 12.6 16.2 25.7 Metals & binereln 204.2 151.3 25.2 7,8 88.9 318.3 64.1 47.5 7.9 2.5 27.9 100.0 22.6 23.1 10.6 11.4 16.3 19.0 Menuefcturen 386.8 260.9 174.6 51.9 367.8 929.2 41.6 28.1 18.8 5.6 39.6 100.0 43.2 39.8 73.2 75.9 67.4 55.3 Chemicais 31.9 22.2 13.4 4.6 51.8 97.1 32.8 22.9 13.8 4.7 53.4 101.0 3.6 3.4 5.6 6.7 9.5 5.8 Machbnery & Transportation Equipment 110.2 78.1 112.3 27.9 158.8 381.3 28.9 20.5 29.4 7.3 41.7 100.0 12.3 11.9 47.1 40.8 29.1 22.7 Other Manofactores 244.7 160.6 48.9 19.5 157.2 450.8 54.3 35.6 10.9 4.3 34.9 100.0 27.3 24.5 20.5 29.3 28.8 26.8 Total 895.3 655.4 238.5 68.4 545.3 16,79.1 53.3 39.0 14.2 4.3 32.5 160.0 190.1 100.0 108.0 100,0 100.0 100.10 1975 PrimRay 696.5 454.5 135.1 75.9 539.4 1,371.0 50.8 33.2 9,9 5.5 39.3 110.0 50.3 48.9 17.5 23.4 28.1 33.7