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Evaluating Regional Policy in Yugoslavia, 1966–1990

Article  in  Comparative Economic Studies · September 1992

DOI: 10.1057/ces.1992.22 · Source: RePEc

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 Evaluating Regional Policy in Yugoslavia,
1966-1990

Evan Kraft*
Salisbury State University

This paper measures the redistribution offinancial and physical resources

to different regions is Yugoslavia that arise from tax exemptions, interest-
rate subsidies, and price distortions. Despite, or perhaps because of the lower
marginal productivity of capital in less-developed regions, the result of poli-
cies adopted between 1966 and 1990 has been a substantial net flow to these
regions. To equalize the marginal product of capital across regions in 1972,
a one-time transfer of45% of the capital stock from the less-developed regions
would have been required. Yet the appropriate regional policy to realize this
objective was not fully adopted by Yugoslav leaders.

Bitter disputes over the distribution of aid across regions played a key
role in the events leading up to the disintegration of the Yugoslav federa-
tion in 1991. While regional aid may indeed have been less significant than
the enormous ideological, social, ethnic and religious differences in Yugo-
slavia, chronic regional economic problems certainly exacerbated other
difficulties. Regional issues played an especially important role in Slovenia's
decision to break away from Yugoslavia in 1990.
Yugoslavia's attempts to resolve its regional problems took place in a
unique environment. The highly decentralized federation in which the Fed-
eral government had few powers beyond providing common defense, main-
taining the legal system, and conducting foreign relations allowed the
communist parties of the constituent republics and autonomous provinces

*The author gratefully acknowledges grants from the Joint Committee on Eastern Europe of
the Social Science Research Council and the American Council of Learned Societies, and the
International Research and Exchanges Board, and the helpful comments of David Gordon,
Deborah Milenkovitch, Diane Flaherty, two anonymous referees and the editor of Compara-
tive Economic Studies. All remaining errors are the author's sole responsibility.

11
12 KRAFT

(called regions here for simplicity) to retain a significant degree of auton-

omy. Yugoslavia's commitment to worker self-management, its renunci-
ation of central planning, and its system of social ownership also shaped
the options available for resolving regional inequities. Overt transfers to
the less-developed regions were combined with unpublicized, discretion-
ary monetary-credit flows. At the same time, price system distortions im-
posed substantial regional disparities.
Previous work evaluating the shortcomings of Yugoslav regional policy
focus in large part on the absence of market forces. Bateman, Nishemuzu
and Page (1988) find considerable microeconomic inefficiencies in Yugo-
slavia's less-developed regions. Milanovic (1987) argues that the growth
pattern after 1966 actually maximized the difference between less-developed
and more-developed regions at the expense of the overall growth rate. Dinkic
(1990) shows that, while output grew faster in the less-developed regions,
total factor productivity grew faster in the developed regions. Moreover,
he developes a synthetic index of efficiency that measures the efficiency
advantages of the developed regions. By contrast, Flaherty (1988) ques-
tions whether market-based solutions could have decreased regional in-
equality. Her results, however, fail to provide strong support for the
hypothesis that market forces were active in Yugoslavia after the reforms
of the mid-1960s.
The objective of this paper is twofold: first, to analyze the impact of market
forces on regional inequities and evaluate the results of regional policy on
the distribution of industry; and second, to analyze the extent to which the
regulated market processes created, or at least perpetuated, an autarkic pat-
tern of growth that fostered significant inefficiencies in the less-developed
regions.
Section I briefly discusses the rationale for and instruments of Yugoslav
development strategy. Section II provides estimates of interregional redis-
tribution, attempting to answer the question "who subsidized whom?" Sec-
tion III compares Yugoslav and European Economic Community (EEC)
regional policies. Section IV analyzes the impact of different regional profit
rates and potential regional capital flows. Section V evaluates the conse-
quences of Yugoslavia's policy choices on the rate, pattern and quality of
industrial growth. Finally, Section VI offers concluding remarks.

Regional Development Strategy: Rationale and Instruments

Yugoslays were fond of pointing out that their country had two alphabets,
three major religions, four official languages and six republics. The eco-
nomic differences among regions are striking (see Table 1). The developed
 REGIONAL POLICY IN YUGOSLAVIA 13

TABLE 1

Indicators of Regional Development

% Population Social
in Product Per Unemployment Population
Agriculture Capita (average 0/0) (1989,
1971 1981 (1988, $) 1967-1975 1976-1987 thousands)

Less-Developed
Regions 42.1 18.6 1375 13.9 20.9 9168
Bosnia 40.0 17.3 1573 7.4 15.7 4479
Montenegro 35.0 13.5 1754 8.3 16.8 639
Macedonia 39.9 21.7 1499 18.9 21.3 2111
Kosovo 51.5 24.6 662 20.5 29.6 1939

More-Developed
Regions 36.4 19.1 3196 6.1 9.0 14522
Slovenia 20.4 9.4 5918 2.5 1.7 1948
Croatia 32.3 15.2 3230 5.2 6.4 4683
Vojvodina 39.0 19.9 3061 7.4 12.7 2051
Serbia* 44.1 27.6 2238 9.2 15.1 5840

Yugoslavia 38.2 19.9 2480 8.1 12.6 23690

*In all tables, "Serbia" denotes "narrow" Serbia (Serbia without the autonomous provinces).

Sources: All data is from Statisticki Godisnjak Jugoslavije. Population in agriculture: 1989,
Table 203-6, p. 440; Social product: 1990, Table 205-2, p. 472 and 203-2, p. 437; Unem-
ployment: 1986, Table 204-1, p. 460, Table 204-7, p. 466 (1978-1985 data), 1990 Table
204-1, p. 461, Table 204-7(1986-1987 data), p. 467; 1981, Table 204-1, p. 420 and Table
204-7, p. 426 (1973-1977 data); 1973, Table 203-1, p. 362 and Table 203-12, p. 375
(1965-1972 data); Population: 1990, Table 203-2, p. 437.

regions, Slovenia, Croatia, Vojvodina and Serbia ("Serbia proper- or "nar-

row Serbia," without the autonomous provinces of Kosovo and Vojvodina)
are characterized by higher-than-average income per capita, and lower-than-
average unemployment rates than for Yugoslavia as a whole. The less-
developed regions tend to have a higher percentage of the population en-
gaged in agriculture.
Despite Yugoslavia's break with the Soviet Union in 1948, her leaders
proclaimed their dedication to the establishment of equality among the coun-
try's constituent nations and nationalities. Yet they relied upon rapid indus-
trialization as the centerpiece of their development strategy. "The conception
of development policy was based on a process of rapid industrialization
14 KRAFT

by means of a great concentration of productive potential in big cities and

massive population migration" (Baletic 1989, p. 312).
The rapid industrialization and thus regional this development strategy
between 1948 and 1965 was mainly carried out in a centralized fashion
through Federation-level investment funds. With the advent of "market so-
cialism" in 1965, control over investment and development policy was rad-
ically decentralized, yet market mechanisms (especially capital markets)
were constrained by political forces (Kraft and Vodopivec 1992, Prasnikar
and Svejnar 1991). Indeed, government leaders mediated interregional cap-
ital mobility, despite simultaneous efforts to encourage independent inter-
regional banking. The Federal Fund for the Crediting of the Development
of the Less-Developed Regions channeled grants and long-term, low-interest
loans to less-developed regions. The Federal Fund, financed by taxes paid
by enterprises in developed regions, was allocated almost exclusively by
the authorities in less-developed regions.
Total Fund disbursements between 1984 and 1988 amounted to 1.4% of
Yugoslav GSP,2 (see Table 2, column 1) but its impact in less-developed
regions was substantial. Interregional investment was based on the redis-
tributive role of Federation-mandated transfers and on a system of import
rationing and licensing that distributed hard-currency resources across
regions. Furthermore, the Federation not only assumed all debts of some
enterprises in less-developed regions, but also channelled foreign invest-
ment to less-developed regions.3 Fund transfers accounted for 71% of total
investment in Yugoslavia's least developed region, the autonomous province
of Kosovo; in Bosnia and Herzegovina it accounted for 2.4% of GSP (10.5%
of total investment during this period).
Non-Fund interregional investment flows amounted to only 0.4% of total
investment in 1982, a year when 98% of enterprise bank deposits were made
locally (Ocic 1986a, p. 302-3). Moreover, legislation prohibited direct
equity investment, allowing only "pooling of funds," a form of investment
that gave the investing enterprise no say over the use of its funds, and pro-
vided no protection against inflation. Effective interest rates on pooled funds
were almost always negative in real terms (Sacks 1983). Finally, constitu-
tional amendments in 1971 clarified the banks' purpose to "service" the
economy, not to make profits.

Measuring Interregional Flows

Kraft and Vodopivec (1992) provide an assessment of the scope of credit-

based instruments of redistribution. Using enterprise-level data for all
 REGIONAL POLICY IN YUGOSLAVIA 15

TABLE 2
Redistribution in Yugoslavia
Federal Fund Net Gains from
Disbursements a Subsidiesb Price Realignmentc
Pi P2

Less-Developed
Regions 57 6.8 4.1
Bosnia 2.4 43 4.0 1.3
Montenegro 5.4 123 11.5 8.1
Macedonia 4.1 35 10.1 7.2
Kosovo 24.2 145 12.9 9.8

More-Developed
Regions 5 5.0 2.0
Slovenia -11 5.0 1.6
Croatia 13 5.1 2.2
Serbiad 10 4.3 4.9
Vojvodina 6.2 6.2

Yugoslavia 1.4 18 5.4 2.4

aDisbursements by the Federal Fund as a percentage of gross social product, average

1984-1988.
bTotal of formal taxes, formal subsidies, quasi-taxes, quasi-subsidies, losses and gains
on money as a percentage of income, manufacturing only. See Kraft and Vodopivec (1992)
cGains from price realignment as a percentage of gross social product, 1976. p1 is based
on a profit rate of 4.1%. p2 is obtained by setting the profit rate equal to .6419 times the
growth rate. For detailed explanation of the calculation of these prices, see Petrovic (1988)
dDue to a defect in the data base, Kraft and Vodopivec were unable to distinguish
Vojvodina from narrow Serbia in their calculation of net subsidies. So the subsidy rate shown
here is for narrow Serbia and Vojvodina together.

Sources: Federal Fund: Statisticki Godisnjak Jugoslavije 1990, Table 207-7, p. 496 and
Table 205-2, p. 472, and 1986, Table 205-3, p. 475. Net Subsidies: Kraft and Vodopivec
(1992) (original data base from Yugoslav Social Accounting Service). Price Redistribution:
Petrovic (1988) for price data; input-output table from Medjusobni Odnosi Jugoslovenskog
Privreda, 1984; output data from Statisticki B//ten #1073, "Drustveni Proizvod i Narodni
Dohodak, 1976" Table 4-2.

industrial enterprises in 1986, they estimated 6 elements of fiscal and mone-

tary redistribution. The first two elements are self-explanatory: formal taxes
and subsidies. The second two elements, quasi-taxes and quasi-subsidies,
result from the Yugoslav practice of "advising" enterprises to pool their
16 KRAFT

funds with other enterprises, often loss-makers, at interest rates below the
rate of inflation. This form of investment effectively taxes the investing
enterprise while subsidizing the receiving enterprise.
The final two elements, losses and gains on money, provide the channel
through which monetary policy enters the picture. Losses on money are
incurred when assets voluntarily held by the enterprise lose value due to
inflation. Gains on money occur when liabilities of the enterprise are simi-
larly devalued. Such liabilities include short- and long-term credits, as well
as liabilities for taxes and contributions.4
National Bank interventions to provide emergency credit for loss-making
enterprises show up as gains on money. Furthermore, commune and republic
budget deficits, often the result of postponement or forgiveness of taxes
for loss-making enterprises, were also sustained via monetary infusions from
the National Bank of Yugoslavia to the National Banks of the various repub-
lics. In other words, the lower rates of taxation found in the less-developed
regions were subsidized in part by the Federation's monetary policy.
The actual flows of quasi-taxes, quasi-subsidies, losses and gains on money
are calculated by applying the inflation rate to appropriate stocks of assets
or liabilities. The general formula is:

RFLOW = INFLR*(BASE0 + BASE2)/2

where RFLOW is the redistribution flow, INFLR is the rate of inflation,

and BASE represents the stock of asset or liability at the beginning and
end of the year (Kraft and Vodopivec 1992).
Table 2, column 2, shows the redistribution flow (labelled "net subsi-
dies"). It is important to identify which of these flows is interregional.
Taxes, with the exception of tariffs, a portion of the turnover tax, and con-
tributions to the Federal Fund, are republic or commune level. Direct sub-
sidies can come from the Federation, but they amount to only 1% of income.
Quasi-taxes and quasi-subsidies are generally intra-republic flows, because
pooling of funds occurs almost exclusively within republics.
Interregional flows are mainly hidden within the category of gains and losses
on money. Both the soft-credits granted by the National Bank of Yugoslavia to
enterprises, and the monetary expansion to finance republic-level deficits,
may show up as gains on money. In terms of net gains on money, less-
developed regions have been the major beneficiaries of National Bank inter-
ventions. In fact, net gains on money amounted to 72% of less-developed re-
gions' income in 1986, far outweighing direct transfers from the Federal Fund.
The magnitude of the redistribution flow depends on two factors: the rate
of inflation and the stocks of assets and liabilities. Although these data apply
 REGIONAL POLICY IN YUGOSLAVIA 17

only to the year 1986, high inflation persisted throughout the 1980s. Whole-
sale prices of industrial products rose from 45% in 1980 to 85% in 1986,
and then accelerated into hyperinflation (about 2000%) in 1988.
The evidence thus suggests that the main redistributive mechanism in
Yugoslavia was monetary-credit policy. In addition, the magnitude of the
numbers involved suggest financial flows of a magnitude significantly larger
than the Federal Fund. Because inflation rates in the 1970s were in single
digits for several years, reaching a maximum of 37% in 1974, it is less
clear whether the magnitude of redistribution was actually as high in the
1970s. There is reason to believe that the volume of credit was higher in
the 1970s than in the 1980s, due to cheap foreign credits coupled with ex-
pansionary monetary and credit policies which fueled rapid growth. But,
until further research can be done, caution must be exercised in using these
estimates to apply to the 1970s.
Buvac (1988) and others suggest that the price system depressed the prices
of commodities produced in less-developed regions, thereby benefitting de-
veloped regions. Petrovic (1988) developed a preliminary price distortion
estimate by analyzing the deviation of actual from equilibrium price levels.
I extend this analysis by employing the 1980 input-output data in combina-
tion with equilibrium prices reported by Petrovic to recalculate the prices
of inputs as well as outputs for industry in each region. From this I esti-
mate the change in revenue that would be obtained by each region under
the calculated equilibrium prices. The change in revenue is given by the
equation:

DR = Pc(I-MY Pa(I-A)Y

where Pc is Petrovic's calculated equilibrium price, Pa is the actual price,

A is the matrix of technical coefficients and Y is the vector of gross output.
The scalar DR is the change in revenue for the region.
This calculation is imprecise in several respects. First, it ignores any sub-
stitution or income effects caused by price changes. Second, it uses the all-
Yugoslav input-output table rather than regional input-output tables. Given
what is known about the efficiency of production in the less-developed
regions, this probably imparts an upward bias to estimates of revenue gains
because it underestimates costs. Third, this calculation treats imports sym-
metrically with domestic inputs, yet export prices are left out of the recalcu-
lation. If the Yugoslav dinar was overvalued this calculation would be biased
against the exporting regions; that is, biased against the developed regions.
Fourth, if Petrovic's estimates of price distortion are too low because of
errors of aggregation, the price effects may be underestimated. Finally,
18 KRAFT

this calculation assumes wages would be unaffected. Given the labor-

managed structure of Yugoslav firms, it is not at all clear that price liber-
alization would directly affect wages. Of course, a price liberalization as
part of a global economic reform, such as the one attempted in 1990, would
most definitely affect wages. In this case, however, nominal wages were
frozen as an anti-inflationary measure, and real wages fell as inflation
continued. Despite these shortcomings, this calculation provides a rough
counter-factual estimate of the actual Yugoslav economy in 1976 with one
functioning at equilibrium prices.
This revenue change calculation, while oversimplified, should provide
a rough upper bound to the effects of price distortions on the regional econ-
omies. As is shown in Table 2 (columns 3 and 4), less-developed regions
stood to gain the most from a price realignment. Price effects appear to
be somewhat smaller than the Federal Fund allocations. For example,
Kosovo gained 24.2% of Social Product from the Federal Fund in the
mid-1980s, and lost between 9.8 and 12.9% from price effects in 1976.
It seems more meaningful, however, to look at changes in the relative
positions of the different regions. At best, Kosovo could have gained only
7.5% from price realignment, relative to the Yugoslav average significantly
less than the 24.2% gain from the Federal Fund. On the other hand, Monte-
negro would have gained between 5.7 and 6.1% from price realignment,
roughly comparable to its 5.4% gain from the Federal Fund in the 1980s.
Similarly Macedonia would have gained some 4.7 to 4.8% from price
realignment, a bit larger than the 4.1% it received from the Federal Fund.
Bosnia would have actually lost 1.1-1.4% from price realignment. Thus,
it appears that the effects of the Federal Fund in the cases of Montenegro
and Macedonia, were roughly balanced out by price distortions. Kosovo
benefitted overall, despite the price distortions, and Bosnia actually gained
from the distorted price system as well as modest Federal Fund allotments.
Keeping in mind the caveats about the calculations and the single-year
data for net subsidies and price distortions, a cautious conclusion would
be that price effects, while substantial, only partly offset Federal Fund trans-
fers. When monetary-credit interventions are added in as well, it appears
that the overall redistribution picture is one of substantial transfers to the
less-developed regions.

Yugoslav Regional Policy in Contrast

with Regional Policy in EEC Nations

While Yugoslav policy attempted to meet many of the same objectives

as Western European countries, the particular instruments employed were
 REGIONAL POLICY IN YUGOSLAVIA 19

far less distinguishable and far less open to public scrutiny. That is, the
contrast between Yugoslav and EEC5 nation policy is evident in a com-
parison of: (1) investment stimulation, (2) employment stimulation, (3) en-
couragement of migration to developed regions, and (4) decision-making
institutions.

Investment Stimulation

EEC nations used a wide variety of financial incentives for investment

in less-developed regions: capital grants, interest subsidies, accelerated
depreciation allowances and tax concessions (Vanhove and Klassen 1980,
p. 316-18). The Federal Fund also provided capital grants and interest sub-
sidies, but only to local government officials or firms located in the less-
developed regions. In contrast to the EEC nations, Yugoslavia did not en-
courage enterprises to relocate or invest in less-developed regions, rather,
it simply financed governments and enterprise activities in less-developed
regions.
Vanhove and Klassen (1980, p. 332) point out the two main disadvan-
tages to this regional policy instrument: high cost, and encouragement of
capital-intensive projects. Both were especially visible in Kosovo and
Montenegro.

Employment Stimulation

Recognizing the capital-intensity bias of investment incentives, many EEC

nations practiced forms of employment-related subsidies. France gave
regional employment grants, Italy gave social security concessions the UK
offered a Regional Employment Premium (REP). Yugoslavia, by contrast,
had no overt regional employment policy, nor any employment incentives
directed towards less-developed regions. In fact, taxes paid by enterprises
on personal income in 1976 were higher in Kosovo (48.6% of after-tax
personal income) and Montenegro (46.8%) than in Croatia (44.3%) or
Slovenia (44.1%). Macedonia had a substantially lower rate, 34.2 % , as
did Bosnia (40%).
While it is tempting to see such skewed incentives as the major cause
of the capital-intensity bias in Montenegro and Kosovo, it may be that the
causation flowed in the opposite direction Dyker (1991) documents the
degree to which political considerations dominated economic decisions in-
volving major investment projects, citing the Belgrade-Bar railway, where
rate of return and technical efficiency considerations were ignored. When
political considerations dominate investment policy, higher taxes on the
20 KRAFT

employed may be needed to compensate for lower employment levels to

secure an adequate revenue base. Such may have been the case in Kosovo
and Montenegro. In that sense, investment policy may have determined
incentivescreating a vicious circle by instituting a further bias toward cap-
ital intensity. In this situation, employment growth in the less-developed
regions was stimulated through informal means. Trickovic (1986) notes that
employment goals embodied in self-management agreements were enforced
by political pressure. Enterprises in all regions were told to hire a certain
number of workers each year, whether needed or not.

Encouragement of Migration to Developed Regions

Several European countries, and a number of agencies (European Coal

and Steel Community, European Social Fund) offered benefits to those will-
ing to relocate to get a job. Such aid generally was found to be of limited
help, in part because resistance to relocation, even when relocation costs
were entirely compensated, was substantial. Moreover, overcrowding in
major urban areas, caused some countries to impose regional development
limits, implicitly discouraging migration.
By contrast, desppite the lack of migration incentives and the urban hous-
ing shortage in Yugoslavia, certain groups were especially mobile, most
notably Bosnian and Albanian workers (Meznaric 1986). In addition, Yugo-
slav authorities took advantage of external migration, as a safety-valve for
unemployment and as an opportunity to reap foreign exchange from guest-
worker remissions.

Decision-making Institutions

Regional policy agencies and state-owned enterprises represent two

decision-making institutions. Several European countries created special
government agencies for regional policy. The most famous was the Italian
Cassa per il Mezzogiorno. Other organizations include DATAR in France,
Regional Development Authorities in the Netherlands, and the Scottish and
Welsh Development Agencies in the UK. In addition, the EEC created
community-level regional authorities such as the European Social Fund
(ESF) and European Reginal Development Fund (ERDF), and a community-
level financial institution, the European Investment Bank.
Yugoslavia had no separate government bureaucracy in charge of regional
policy. Allocations to the Federal Fund were fought over in the Federal
Parliament and within the League of Communists but the actual adminis-
tration of Fund moneys was left to the recipient Republics. Many criticized
 REGIONAL POLICY IN YUGOSLAVIA 21

the allocation and administration process, proposing instead the formation

of a development bank (Goldstein and Korosic 1987).
Despite being a socialist country, Yugoslavia had no equivalent to the
state-owned companies found in most EEC countries. In Italy, for exam-
ple, state-owned firms were given targets for investment and employment
in the Mezzogiorno (Harrop 1989, p. 110). There were no federal enter-
prises to be given such a regional policy role in Yugoslavia.6

Profit Rate Differentials and Capital Flows

in an Unregulated Market

Could market processes correct income disparities in Yugoslavia? What

impact on capital flows would have occurred had Yugoslavia simply liber-
alized goods and factor markets in one stroke?
In perfectly competitive markets, profit rates are determined theoretical-
ly by the marginal product of capital. In Yugoslavia, however, the magni-
tude of price level changes associated with price liberalization, the structure
of the labor-managed firm,7 and the notion that capital actually receives
its marginal product (which can be challenged on several grounds), sug-
gests that such an outcome is highly improbable. Even after full liberaliza-
tion the Yugoslav market would necessarily remain highly concentrated,
thus prolonging the disequilibrium effects.
It is therefore necessary to estimate both the marginal product of capital
and calculate average rates of profit for the regions.8 Neither the observed
average nor the estimated marginal profit rate are likely to be the exact
entry rate sought, but if both indicate capital flows to the developed regions,
the case becomes fairly strong. Marginal profit rate estimates are given in
Table 3, "cash-flow" rates in Table 4.
With the exception of Macedonia in 1972-1975,9 marginal profit rates
in less-developed regions are lower than those in developed regions. In ad-
dition to an overall declining trend in marginal profit rate, both the abso-
lute and relative percentage gap between profit rates in less-developed and
developed regions narrow after 1971, both gaps rise thereafter.
The deterioration of performance in less-developed regions after 1975
was the product of a campaign to raise domestic supply (Bole and Gaspari
1991). Rapid investment based on import-substitution and large-scale
purchases of (often obsolete) foreign licenses lengthened the absorptive
capacities in less-developed regions, harming performance. After the
(1979-1981) debt crisis ended the period of rapid growth performance in
less-developed regions was further strained by financial crisis and low
investment.
22 KRAFT

TABLE 3
Marginal Product of Capital
1967-1971 1972-1975 1976-1982 1983-1987

Less-Developed
Regions 12.1 7.4 6.5 6.6
Bosnia 13.3 8.8 7.0 7.7
Montenegro 10.5 5.2 6.5 9.0
Macedonia 15.7 11.7 7.8 7.2
Kosovo 8.8 4.7 4.6 2.5

More-Developed
Regions 19.8 11.6 11.0 11.2
Slovenia 21.4 8.1 9.5 9.9
Croatia 20.0 9.9 13.5 14.2
Vojvodina 19.2 15.0 11.7 11.0
Serbia 18.6 12.1 9.4 9.8

Yugoslavia 17.6 10.4 9.7 9.9

Profit gap 7.7 4.2 4.5 4.6

(%) 39.0 36.0 41.0 41.0

Sources:
For labor and output in current prices, 1966-1977:1966: Statisticki Godisnjak (SG) 1967,
Tables 207-4 and 207-5; 1967: SG 1968, Tables 207-4 and 207-5; 1968: SG 1969, Tables
207-4 and 207-5; 1969: SG 1970, Tables 207-4 and 207-5; 1970: SG 1971, Tables 207-4
and 207-5; 1971: SG 1972, Tables 207-4 and 207-5; 1972: SG 1973, Tables 208-4 and
208-5; 1973: SG 1974, Tables 208-4 and 208-5; 1974: SG 1975, Tables 208-4 and 208-5;
1975: SG 1976, Tables 208-4 and 208-5; 1976: SG 1977, Tables 214-4 and 214-5; 1977:
SG 1978, Tables 215-4 and 215-5.

For labor, and output and capital in current prices, 1978-1987:1978: Statisticki Bilten (SB)
#1178, Tables 2-2 to 2-10; 1979: SB #1236, Table 2-2; 1980: SB #1297, Table 2-2; 1981:
SB #1357, Table 2-2; 1982: SB #1442, Table 2-2; 1983: SB #1478, Table 2-6; 1984: SB
#1524, Table 2-6; 1985: SB #1609, Table 2-6; 1986: SB #1676, Table 2-6; 1987: SB #1739,
Table 2-6.

Capital stock: Data set with constant price data for capital stock disaggregated to the regional
level for 1966-1978 provided to author by Deborah Page, World Bank.

Constant price data for capital stock, Yugoslavia, for deflation: SB #1178, Table 10
(1971-1978); SB #1739, Table 15; (1978-1987).

Constant price data for output (3ross Social product), Yugoslavia, for deflation: SG 1984,
Table 107-1, (1966-1983); SG 1988, Table 107-1, p. 166 (1983-1987).
 REGIONAL POLICY IN YUGOSLAVIA 23

TABLE 4
Average "Cash-Flow" Profit Rate*
1972-1975 1976-1985 1983-1987

Less-Developed
Regions 6.7 4.0 4.0
Bosnia 9.4 6.0 4.8
Macedonia 8.4 5.3 5.7
Montenegro 5.7 2.7 2.0
Kosovo 3.4 1.9 3.6

More-Developed
Regions 13.4 10.3 8.4
Slovenia 14.8 10.8 10.0
Croatia 13.4 10.8 8.9
Vojvodina 13.8 9.8 7.2
Serbia 11.5 9.8 7.6

Yugoslavia 11.8 8.8 7.3

Profit gap 6.7 6.3 4.4

(%) 50.0 62.0 52.0

*Data needed to calculate the "cash-flow" profit rate were not published in their entirety
for the years before 1971.

Sources: See Table 3.

Would it have been possible to reallocate capital from less-developed

regions to developed regions in order to equalize profit rates in the two
areas? Using 1972 data and the production function estimates provided in
Appendix A, I calculate that a reallocation of 32 billion dinars would have
resulted in a marginal product of 11.1 % in each area. The developed regions
would have received an injection equal to 17.1 % of their capital stock, while
the less-developed would have lost 45.2% of their capital stock by such
a reallocation!
The data in Table 4 reinforce this scenario using the "cash-flow" meas-
ure, industry profitability in developed regions is greater than in less-
developed regions. While the profit gap narrows somewhat (from 6.7%
in 1972-1975 to 4.4% in 1983-1987), the percentage gap is actually widest
between 1976 and 1982.
Do price distortions explain regional profitability differences? In Table
5, the effect of price adjustments is noted as "revenue change/capital stock."
24 KRAFT

TABLE 5
Effect of Price Changes on "Cash-Flow"
Profit Rates, 1976
Unadjusted Corrected
"Cash-Flow" Revenue Change/ Profit
Profit Rate Capital Stock Rate

Less-Developed
Regions 1.0 2.0 3.0
Bosnia 4.9 1.4 6.3
Macedonia 1.6 3.0 4.6
Montenegro -0.7 2.1 1.4
Kosovo -2.1 2.7 0.6

More-Developed
Regions 9.1 2.1 11.2
Slovenia 10.7 2.2 12.9
Croatia 9.3 2.2 11.5
Vojvodina 8.1 2.8 10.9
Serbia 8.3 1.6 9.9

Yugoslavia 7.3 2.0 9.3

Sources: See Table 3.

Such an adjustment hardly makes a dent in the regional dispersion of profit

rates because of the higher capital-output ratios in the less-developed regions.
Our upper bound estimate of 45.2% of total capital stock in less-developed
regions suggests that in an unregulated market, capital flows from less-
developed to developed regions would have been substantial. To avoid such
perverse flows, and to boost the development of the less-developed regions,
it was necessary to design an effective regional policy.

Regional Policy Consequences

Yugoslav regional strategy aimed at achieving development parity by in-

dustrializing the less-developed regions. In practice, this was achieved
despite the lower profitability of average and marginal investments in the
less-developed regions. This could well be argued to be the major achieve-
ment of Yugoslav regional policy.
Table 6 shows both the share of industry in total output and the rate of
growth of industrial production between 1966 and 1990. By 1965, the less-
 REGIONAL POLICY IN YUGOSLAVIA 25

TABLE 6

Dynamics of Industrial Output in Yugoslav Regions

1965-1987
Share of Share of Growth Rate of
Industry in Industry in Industrial
Output in 1965 Output in 1987 Production, 1965-1987

Less-Developed
Regions 35.3 48.9 5.7
Bosnia 38.0 50.2 5.3
Macedonia 31.9 51.5 6.8
Montenegro 30.7 36.5 5.0
Kosovo 30.9 45.2 6.1

More-Developed
Regions 33.9 42.7 5.1
Slovenia 42.3 47.0 4.9
Croatia 33.4 38.4 4.5
Vojvodina 30.7 41.6 5.2
Serbia 30.7 44.7 5.7
Yugoslavia 30.8 44.1 5.7

Source: Statisticki Godisnjak Jugoslavije, 1990, Table 205-2, p. 473.

developed regions already produced a higher percentage of their output in

industry than the developed regions. In fact, over the next 20 years indus-
trial output in less-developed regions grew faster than in developed regions.
The share of industrial output (48.9%) also exceeded that of developed
regions (42.7%) by 1987.
The experiences of Macedonia and Kosovo are particularly noteworthy.
Macedonian industry, which received the least net subsidies of all less-
developed regions from fiscal and monetary redistribution in 1986, was ap-
parently hurt by price distortions almost as much as Kosovo and Monte-
negro. Although Macedonian enterprises received lower Federal Fund aid
in relation to total industrial output relative to Kosovo and Montenegro,
nonetheless this region developed at a rapid pace. According to Dinkic
(1991), total factor productivity grew faster in Macedonian than in the other
less-developed regions during the period.
At the same time, Kosovo's industry, which received almost 6 times more
Federal Fund aid in relation to its output than Macedonia, benefitted about
4 times more from redistribution in 1986 than Macedonia. From a price
26 KRAFT

standpoint, however, Kosovo was 10-15% worse off. The aid pumped
into Kosovo may have exceeded the region's absorptive capacity. Further-
more, project selection in Kosovo has been highly controversial from an
economic perspective(expensive library built in Pristina in the 1980s)
for example.
Emergency Aid dominated in Kosovo, especially after the riots in 1981.
Continuing political instability in Kosovo has greatly complicated economic
development efforts. Therefore, the apparent inefficacy of Yugoslavia's aid
to Kosovo cannot be taken as entirely typical of Yugoslav regional policy
in general.
Another way of looking at the effectiveness of regional policy is to
examine the dynamics of output per capita (see Table 7). The gradual fall
GSP per capita in the less-developed regions is striking. Each less-developed
region experienced a decrease relative to the Yugoslav average, although
Montenegro and Macedonia's are fairly small. From this point of view,
Yugoslav regional policy appears to have failed. A more accurate evalua-
tion is based on a comparison of the achieved policy results and the probable
outcomes in the absence of such policy. Our estimated profit rates strongly
suggest that Kosovo in particular, and probably all of the less-developed
region, would have grown very slowly in an unregulated market without
a regional policy.
In the absence of consistent time series on price distortions and fiscal
and monetary redistribution, we can only assess the efficiency of Yugoslav
regional policy on the basis of its side effects. Two important aspects stand
out. The first is the inability of regional policy to overcome the autarkic
nature of regional economies. The second is the way in which regional policy
contributed to the "soft-budget" syndrome.
Yugoslav authors argue about whether the degree of autarky among
regions actually increased. Ocic (1986a) points to evidence of declining in-
terregional trade flows in the 1970s. He sees this as the result of the con-
stitutional amendments of 1971 limiting interregional banking, and the
Constitution of 1974, which formally devolved authority to regional govern-
ments. Similarly, Kraft (1989) shows that the structure of regional indus-
trial capital stocks has converged over time, reinforcing the notion of
increased autarky. Bicanic (1988) argues that autarkic development was
simply a response to an extremely rigid and dysfunctional economic sys-
tem. Hence autarky was driven by a need to adapt, rather than a desire
for autarky per se. Burkett and Skegro (1988), on the other hand, argue
that there is no evidence of systematic change in the degree of autarky.
Using three different measures, they find no time trend for variables meas-
uring autarky.
 REGIONAL POLICY IN YUGOSLAVIA 27

TABLE 7
Gross Social Product Per Capita as a Percentage
of the Yugoslav Average, 1965-1987
1965 1975 1987

Less-Developed
Regions 65.1 60.5 59.6
Bosnia 71.7 65.6 68.0
Montenegro 76.3 68.9 75.1
Macedonia 66.6 67.8 65.5
Kosovo 36.5 33.3 27.4

More-Developed
Regions 117.8 122.4 125.0
Slovenia 183.2 211.8 203.6
Croatia 120.3 122.8 126.8
Vojvodina 112.5 114.8 118.7
Serbia 96.3 96.4 99.5

Yugoslavia 100.0 100.0 100.0

Source: Statisticki Godisnjak Jugoslavije, 1990, Tables 203-2, p. 437 and 205-2, P. 473.

The least common denominator of all these findings is that Yugoslav

regional policy has not succeeded in integrating the regional economies into
the federal economy. The consequences of this failure are quite serious.
First, autarkic development has led to wasteful duplication of capacity. Not
all of this has occurred between republics; rival communes within a given
republic sometimes created several factories when only one factory was
justified by projected demand. Second, autarky implies diminished com-
petition for regional producers. This uncompetitive atmosphere was inten-
sified by high, non-uniform tariffs on imports as well. Third, autarky may
even have led Yugoslav regions to prefer imports to products from other
republics. This was particularly true in the 1970s, when cheap foreign credit
was available, making it easier to purchase imports than domestic goods.
In addition to encouraging (or at least failing to curtail) autarky, Yugo-
slav regional policy encouraged the soft-budget constraint. Regional redis-
tribution flows responded very strongly to enterprise losses. Yugoslav
enterprises in the less-developed regions simply assumed that their bad debts
would be taken over. Moreover when regional banks and governments "put
out the fire," they were eventually reimbursed by the National Bank. The
consequence of this was further increase in the money supply, and another
ratcheting up of inflation for the country as a whole. Those regions that
28 KRAFT

practiced greater fiscal discipline failed to reap the fruits of their labors,
because the indiscipline of other regions affected everyone.
The extent of these weaknesses manifested itself when Yugoslavia turned
decisively toward market relations following its May 1988 agreement with
the International Monetary Fund. The May agreement and the policies
adopted thereafter created a far more competitive environment than Yugo-
slavia had previously experienced. Foreign trade was almost completely
decentralized and tariff barriers were systematically reduced (OECD 1991).
The response of the regional economies to liberalization gives a useful
indication of their strength. The data in Table 8 show two indicators of
economic fragility during liberalization: the percentage of employed workers
in insolvent enterprises, and the ratio of problem loans to total loans. Neither
measure is a perfect indicator of weakness. Both insolvency and bad loans
depend on overall monetary policy, which was extremely tight in 1990 as
government officials tried to reduce hyperinflation. Some viable enterprises
may have come insolvent simply because their customers failed to make
timely payments. Furthermore, in the first months of 1990,1° enterprises
with limited export possibilities faced a harder demand constraint than those
able to sell abroad. At the same time, many economically unviable firms
may not have shown illiquidity in the first few months of stabilization.
Hence, the illiquidity indicator can be argued to give a rough indication
of the economic health of regional economies when exposed to a competi-
tive environment. Likewise, the bad loan indicator is a much a measure
of the level of financial discipline imposed by regional banks and govern-
ments as an indicator of economic health.
The picture painted by these two measures is one of substantial weak-
ness in the less-developed regions. The plight of Montenegro and Kosovo
stand out. With the exception of Serbia the less-developed regions are gener-
ally weaker than the developed regions. The enormous insolvency level in
Serbia probably reflects the resistance of the Serbian government to the
whole Yugoslav reform effort in the years 1988 to 1990. Knowing that their
government did not believe in bankrupting enterprises, Serbian managers
continued to avoid rationalizing production and reducing losses.

Conclusions

The evidence presented here suggests that the less-developed regions were
the major beneficiaries of interregional flows. Price distortions appear to
have offset Federal Fund contributions for Macedonia and Montenegro.
Interventions from the central bank appear to have provided significant net
subsidies to these Republics, and to Kosovo and Bosnia as well. When
 REGIONAL POLICY IN YUGOSLAVIA 29

TABLE 8
Indicators of Economic Fragility
Percentage of Workers in Percentage of Problem
Constantly Insolvent Firms Loans in Total Loans
1988b
March, 1990a December,

Less-Developed
Regions 16.2 14.9
Bosnia 12.8 5.2
Macedonia 11.3 7.3
Montenegro 35.3 40.5
Kosovo 31.3 25.3

More-Developed
Regions 15.7 8.8
Slovenia 2.8 3.7
Croatia 12.1 10.7
Serbia 27.1 9.1
Vojvodina 11.1 8.4

Yugoslavia 15.8 10.5

aSource: Zlatic and Rogecevic, 1990, p. 11.

bSource: Grlickov, 1990, p. 21.

compared to regional policies in the EEC, Yugoslavia's policy is noteworthy

for its opacity, for its lack of explicit labor market components, for its failure
to correct biases to capital-intensity (especially in Kosovo and Montenegro),
and for its lack of Federal-level institutions. The preponderance of evidence
suggest capital flows from less-developed to developed regions in an un-
regulated market. Rapid industrial growth in less-developed regions would
thus appear to be a significant success of Yugoslav regional policy. However,
certain negative side-effects, such as the toleration or even promotion of
regional autarky and the encouragement of the soft-budget constraint, which
hurt the economy of the country as a whole, also emerged.
The former republics of Yugoslavia are now realigned as 5 new states.
The most hopeful scenario imaginable at this point is the formation of a
free-trade zone following the end of the current fighting. Such a free-trade
zone (including freedom of movement for labor and capital) would offer
several positive features: the less-developed regions could set their own
exchange rates, affording a degree of protection against developed regions'
products; the developed regions would be uninvolved in less-developed
regions fiscal and monetary policy; and direct foreign investment by
30 KRAFT

developed regions in less-developed regions could become significant for

both sides.
Unfortunately, however, lower interregional (now international) aid levels
could hamper the prospects of the former less-developed regions. Perhaps,
with generosity from the former developed regions, some of the losses in
aid could be restored. If so, a "Yugoslav Community" might have a
reasonable chance to offer prosperity to all of the former Yugoslav Repub-
lics. But this can only happen if peace breaks out-a most unlikely prospect
at the present time.

APPENDIX

TABLE A-1
Coefficient Estimates and Test Statistics for Production Function'
1967-1971 1972-1975 1976-1982 1983-1987
R2 c R2 c R2 c R2

Bosnia .53 .83 .32 .97 .27 .91 .31 .88

(10.32) (10.00) (9.34) (7.29)
Montenegro .56 .75 .27 .89 .36 .84 .47 .62
(12.29) (5.62) (11.45) (7.56)
Croatia .50 .61 .28 .85 .40 .89 .44 .85
(9.86) (5.47) (14.27) (10.85)
Macedonia .52 .69 .39 .97 .26 .93 .21 .85
(8.20) (9.26) (9.90) (4.82)
Slovenia .53 .76 .21 .92 .27 .93 .29 .90
(10.70) (4.40) (7.90) (5.64)
Serbia .54 .76 .38 .89 .29 .87 .33 .88
(11.11) (6.55) (7.65) (7.80)
Kosovo .35 .66 .22 .83 .20 .87 .12 .83
(7.47) (4.92) (4.58) (12.25)
Vojvodina .54 .84 .40 .95 .35 .91 .41 .91
(11.80) (10.74) (13.48) (10.45)

aThe coefficient estimates pertain to the log-log specification of the Cobb-Douglas Produc-
tion Function:

In Y = a + b InL + c InK + dt + e

where Y is output, L labor, K capital and t time. The equation was estimated using ordi-
nary least squares. Reported are the estimates for c, the coefficient of Ink (with t-statistics
in parentheses), and the R2 statistic.
 REGIONAL POLICY IN YUGOSLAVIA 31

For the years to 1975, each region included 19 industries per year. Some
industries were not present in some regions, however; for example, Kosovo
does not have an oil industry. For later years, thanks to a new industrial
classification, regions included 35 industries.
The periodization for Yugoslav cycles follows that used in Kraft (1989).
The trough years are 1966, 1971, 1975, 1982 and 1987. A cycle was con-
sidered to start the year after the trough, and to proceed through the year
including the next trough.
The marginal products are calculated from estimates of the coefficients
in the log-log form of the Cobb-Douglas specification.

Notes

For discussion of the origins and features of Yugoslav federalism, see Rusinow
(1976) and Berg (1983).
The Yugoslav concept of Gross Social Product is quite similar to the Soviet
concept of Gross Material Product. The main difference between GSP and Western
GNP concepts is the exclusion of "unproductive" activities from GSP, see
Baletic (1989, P. 320) comments that these instruments were not provided for
in the constitution, but were taken to the point of completely restructuring the finances
of republics and autonomous provinces.
For a full list of the elements of each of the redistribution parameters, see
the appendix in Kraft and Vodopivec (1992).
I refer to EEC, rather than EC, practice to emphasize my focus on the 1960s
and 1970s.
Note, however, that the Yugoslav People's Army was a federal institution with
funds that could be allocated to various regions. Its impact on Yugoslavia's regional
policy, however, cannot be directly assessed due to the secrecy over military produc-
tion and activities.
There is some controversy about whether the "Illyrian" or "LM" analysis
applies, however. See Horvat (1967) and Kraft and Vodopivec (1992) for two differ-
ent sorts of objections to the Illyrian view.
The concept of profit does not exist in Yugoslav accounting. Instead, a Marxian
notion of surplus is used. Surplus is equal to total revenue minus material costs
minus personal income (wages). In the calculations below, I calculate profit as surplus
minus taxes on personal income, interest and insurance payments, and unproduc-
tive services (accounting and the like).
Remaining in the category of profits are: taxes on net income, turnover tax, and
funds used for enterprise purposes. This notion of profit, then, is gross of taxes.
I call it "cash-flow" profit.
Dinkic (1990) finds that Macedonia is the only less-developed region with a
rate of Total Factor Productivity growth above the Yugoslav average for 1966-1987.
32 KRAFT

10. Note that exports were stimulated by time lags between import purchases
and export sales. The intervening devaluation raised export revenues vis-a-vis im-
port cost, providing a short-lived stimulus to exports.

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