Montenegrin Journal of Economics

Volume 11 Number 2 December 2015

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MONTENEGRIN JOURNAL OF ECONOMICS N0 2, Vol. VII Montenegrin Journal of Economics, Vol. 11, No. 2 (Dec. 2015)

Editor in Chief Veselin Draskovic, University of Montenegro, Maritime Faculty of Kotor, Montenegro

Co-Editors Yuriy Bilan, University of Szczecin, Faculty of Economics Science and Management, Poland Yochanan Shachmurove The City College of the City University of New York, Department of Economics and Business, USA Radislav Jovovic University Mediterranean, Faculty of Business Studies, Montenegro

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Montenegrin Journal of Economics, Vol. 11, No. 2 (December 2015)

Siu Lee Jasmine Lam Nanyang Technological University, Singapore Valeriy Makarov Central Economics and Mathematics Institute of the Russian Academy of Sciences/ Lomonosov's Moscow State University / New Economic School, Rusaia Vladimir Matveenko National Research University Higher School of Economics, St. Petersburg, Russia Alojzy Nowak University of Warsaw, Faculty of Management, Poland Yuriy Osipov Lomonosov's Moscow State University, Faculty of Economics, Russia Jiancai Pi School of Business, Nanjing University, China Evgeniy Popov Institute of Economics, Urals Branch of Russian Academy of Sciences, Ekaterinburg, Russia Uriel Spiegel Bar-Ilan University, Faculty of Social Sciences, Ramat-Gan, Israel Aleksandr Tatarkin Institute of Economics, The Ural Branch of Russian Academy of Sciences, Ekaterinburg, Russia Merih Uctum The Graduate Center City University of New York, USA João Paulo Vieito Polytechnic Institute of Viana do Castelo, Portugal Milos Vulanovic City University of Hong Kong Eric Wdoviak Farmingdale State College, New York, USA Bagrat Yerznkyan Central Economics and Mathematics Institute, Russian Academy of Science / State University of Management Moscow, Russia

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Sanja Bauk University of Montenegro, Faculty of Maritime Studies Kotor, Montenegro Mimo Draskovic (Secretary of Editorial Boards) University of Montenegro, Maritime Faculty of Kotor, Montenegro Gordan Druzic Croatian Academy of Sciences and Arts, Zagreb, Croatia Nikola Fabris University of Belgrade, Faculty of Economics, Serbia Miomir Jaksic University of Belgrade, Faculty of Economics, Serbia Borut Jereb University of Maribor, Faculty of Logistics Celje, Slovenia Slobodan Lakic University of Montenegro, Faculty of Economics Podgorica, Montenegro Milan Lakicevic University of Montenegro, Faculty of Economics Podgorica, Montenegro Andjelko Lojpur University of Montenegro, Faculty of Economics Podgorica, Montenegro Ljubomir Madzar Institute of strategic studies and development „Petar Karić“ of the Alfa University in Novi Beograd, Serbia Joze Mencinger University of Ljubljana, Law School, Slovenia Janez Prašnikar University of Ljubljana, Faculty of Economics, Slovenia Milivoje Radovic University of Montenegro, Faculty of Economics Podgorica, Montenegro Ivan Ribnikar University of Ljubljana, Faculty of Economics, Slovenia Guste Santini University of Zagreb, Croatia Ivo Speranda University of Dubrovnik , Department of Economics and Business Economics, Croatia Dragoljub Stojanov University of Rijeka, Faculty of Economics, Croatia

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E.V. Popov, I.S. Katz, A.Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 5-17

Montenegrin Journal of Economics

Vol. 11, No. 2 (2015) ‘

C O N T E N T S

Economic Advantages and Disadvantages of Turkish Eu Accession Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski ...... 7

Evaluating the Social Infrastructure of Municipalities Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova ...... 31

The Determinants of Unemployment and the Question of Inclusive Growth in Nigeria: Do Resource Dependence, Government Expenditure and Financial Development Matter? Frank Iyekoretin Ogbeide, Hillary Kanwanye, Sunday Kadiri ...... 49

Social Entrepreneurship in Romania: Significance and Models Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu ...... 65

Using Marketing Approach to Respond to Internationalization Challenges and Changes in Marketing Channels Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic …………………………………...... 79

Characteristics of the Economic Development of the Multi-Ethnic Regions of Russia Svetlana Panikarova, Maxim Vlasov...... 101

Implications of Institutional Dispositions of Neoliberalism Slobodan Lakic, Mimo Draskovic ………...... 113

The Day-ahead Energy Market Forecasting in Russian Federation: a Case Study of Siberia Alexander Filatov, Evgeny Lisin, Evgenya Smirnova ...... 125

The Relation Between the Attractiveness and Value of Districts in Warsaw Radosław Trojanek ...... 137

Author Guidelines ...... 147

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30

Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 7-30 ‘

Economic Advantages and Disadvantages of Turkish EU Accession

Rashad Gurbanov1, Yuriy Bilan2, Wadim Strielkowski3

1 M. Sc. Faculty of Social Sciences, Charles University in Prague, Czech Republic, E-mail: [email protected] 2 Assoc. Professor, Microeconomics Department Faculty of Economics Science and Management University of Szczecin, Szczecin, Poland, E-mail: [email protected] 3 Assoc. Professor National University of Ireland, Galway, Republic of Ireland, E-mail: [email protected]

ARTICLE INFO ABSTRACT Received October 14, 2015 The subject of our paper is the hypothetic advantages and disad- Received in revised from - vantages of Turkey’s accession to the EU and, therefore, the level of Accepted December 25, 2015 development of the Turkish economy, especially those macroeco- Available online Dec. 03, 2015 nomic and microeconomic criteria which are considered as the EU membership criteria for candidate countries. JEL classification: The main goal is to determine the extent to which Turkey reached F15, F47 the level of economic development of the EU requirements, determine the characteristics and patterns of economic integration proc- DOI: esses related to this state’s accession to the existing union of coun- 10.14254/1800-5845.2015/11-2/1 tries whose level of development is higher than its own one, as well as to evaluate the prospective opportunities of Turkey’s full-scale Keywords: economic integration with the EU. The methodological basis of the International trade, research conducted within the thesis is linked with a systematic Integration, approach using the historical method, the method of comparative EU enlargement, analysis, as well as methods of analysis of economic statistics. Economic implications, EU accession, Turkey, European Union

1. INTRODUCTION The relations between the European Union (EU) and the Republic of Turkey, namely in the field of Turkey’s gradual procession from an associate to full-fledged member of the European Union, dates back to the 1960’s. In 1999, Turkey received the status of candidate for membership, however with greater doubts on the side of the EU member states than in the case of the countries of Central and Eastern Europe (see Guerin and Stivachtis, 2011; Jiroudková et al., 2015). As of today, most CEE countries are already EU members, whereas the accession negotiations with Turkey started only in 2005. The negotiation process was complicated by the emergence of various problems and has been repeatedly interrupted. This complicated nature of relationships puts on the agenda the question of their actual content, grounding the assumption that the process of Turkey's accession to the EU is regulated 7

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 not only by objective membership criteria, but is also influenced by the EU’s subjective approach to Turkey. In order to examine the existence of the alleged element of subjectivity from different perspectives, in this thesis, I would like to conduct an analysis of the actual compliance of Turkey’s level of economic development with the EU criteria which include a number of purely economic aspects, but as well numerous institutional, legal and other points that could not be covered in my work. The importance of such an analysis in order to understand the current state and prospects of relationships between Turkey and the EU explains the relevance of the research topic. The exploration and evaluation of the extent to which the level of Turkey’s economic development meets both general and some more specific parameters and requirements of the EU can also help identify the economic and institutional problems that will be the main substance of the relationships between Turkey and the EU in the future, and at the same time can be useful in the process of identification and prediction of important trends in the transformation of the national economy in case of a very likely enduring of the policy of Turkey in the development of integration with the EU. In addition to the theoretical analysis, I will also run a comprehensive statistical analysis of Turkey’s key financial and macroeconomic indicators, for which purpose I will use an empirical model of statistical regression. This is important for tracking the dynamics of Turkey’s financial and macroeconomic positions, and evaluating how such positions may prospectively affect the country’s course toward integration with the European Union. At the same time, such analysis will make it possible to define the weakest points of the Turkish economy which currently do not allow meeting in full the requirements of the European Union, thus braking the entire process of further European integration.

2. STATE-OF-THE-ART: TURKEY AND THE EU The first studies trying to assess the state of economic relations between Turkey and the EEC countries and to evaluate Turkey’s prospects for European integration (see Shorter et al., 2011) emerged in the mid-1960s., i. e. after the country had received the status of associate member. A few years later, with the active development of bilateral relations, the problem of economic relations between Turkey and the EEC (EU) gained coverage in numerous publications. Meanwhile, a particular feature of almost all studies was that they were dedicated to a comprehensive analysis of relations between Turkey and the EU, with a focus on the political relationship between the parties, and paid weaker attention to the analysis of the component of economic cooperation. In 1999, the study of M. Ugur was published ("The European Union and Turkey: An Anchor/credibility Dilemma"), but at that time, the Republic of Turkey had not received a candidate status yet. Later works such as Clesse’s “Turkey and the European Union: 2004 and Beyond” or “Turkey's Accession to the European Union: Political and Economic Chal- lenges” by Akçay and Yilmaz provide an analysis of the changes in the Turkish economy under the influence of the harmonization process, which started after gaining this status, as well as the estimates of adequacy of those changes in terms of the EU. An essential part in the analysis of the subject is played by the annual reports issued by the European Commission on Turkey's progress on the way to EU membership (Turkey Progress Reports), as well as the Pre-accession economic programs of the Republic of Turkey (Katılım Öncesi Ekonomik Programları) developed by the State Planning Organization of Turkey and approved by the Supreme Council. If, in the first case, the European Commission experts estimate the overall level of harmonization achieved by the national economy and completeness of implementation of the set of specific targets for its deepening, the latter contain the official version of the Turkish side concerning the assessment of the current state of the economy, advances in the field of harmonization, and the economic problems, solution of which will be the main goal of work within the process of European integration. The problem of the analysis of

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 regular progress reports is connected with multiple changes in their structure associated with the revision of the priorities of the European Commission and the assessment system during the period analyzed. As of today, the relations between Turkey and the European Union in the field of Turkey’s integration as the EU’s full-fledged member remain strained. Despite of the fact that Turkey has been able to achieve significant progress on the way toward its accession to the European Un- ion, there are still many obstacles to the effective implementation of those processes, and some of the current EU member states actively oppose Turkey’s accession due to their fear that it would lead to the aggravation of negative processes in the Union. The position of Cyprus with regard to Turkey’s accession to the EU has remained the same throughout the entire process of negotiations. In 2006, Cyprus blocked several chapters of Tur- key’s negotiations for accession with the European Union. Due to this, the process of negotiations was in fact suspended, as Turkey was unable to open any other new chapters in the process of negotiations with the European Union. In 2013, Turkey undertook measures to renew the negotiations process, as it claimed the blockage of chapters by Cyprus to be illegal and not complying with the principles established within the European Union. However, the EU rejected those claims due to which rumors emerged that Turkey would completely stop any further initiatives to obtain the official membership status, and the issue of Turkey’s accession to the Euro- pean Union would remain frozen (see Strielkowski and Gazar, 2014). Due to the lack of chapter opening, and thus due to the suspension of Turkey-EU bilateral negotiations for Turkey’s accession to the European Union, in 2011, the European Union adopted the so-called Positive Agenda governing the EU-Turkey bilateral cooperation and focusing on the common interests of both sides. This document was primarily destined to defreeze the stagnated process of negotiations, however it still didn’t offer any substantial progress fro Turkey in terms of obtaining the status of EU member state. To the contrary, the Positive Agenda again stressed that intensified dialogue needs to be held in the field of political reforms, visa-free regime, free movement of capital, development of the customs union. The positive Agenda also dealt as well with those negotiation chapters which were blocked by Cyprus. How- ever, no provisions were stipulated with regard to how the negotiation process could be de- frosted, as there were no changes in the Turkey-Cyprus controversies. Although the Positive Agenda didn’t provide for any advancement of the process of Turkey-EU negotiations for Tur- key’s accession to the European Union, this document was and still remains very important from the perspective of attempts to give a new impetus to the cooperation between the Euro- pean Union and Turkey. In case that some prospects could be achieved for Turkey in terms of its accession to the European Union in the future, the Positive Agenda could play an important role as the basic act for all subsequent actions in this field (see Strielkowski et al., 2014). In 2013, the situation with the bilateral negotiations between Turkey and the European Un- ion again worsened. On the one hand, the Turkish officials declared their desire to terminate the negotiations and obtain full membership by the year of 2023, otherwise Turkey would finally withdraw from the process of negotiations, and would stop its European integration alternatives. However, Germany declared that it would not waive its veto to defreeze the currently frozen chapters in the Turkey-EU bilateral negotiations for Turkey’s accession to the European Union. Moreover, another leader of the European Union, France, stated that no negotiations would be renewed with Turkey until the end of the European Parliament elections to be held in July 2014. In addition to the aforementioned negative factors preconditioning such an attitude on the part of the European Union, the new wave of negative reaction of the European authorities was caused by the 2013-2014 mass protests in Turkey which were suppressed by the government of Turkey. Opponents of Turkey’s accession to the European Union claimed that the Turkish government roughly violated human rights and freedoms, suppressed the free media, and made a number of other violations incompatible with the democratic principles and approaches promoted within the European community (Cabelkova, at al., 2015). As a result of such position 9

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 of the European Union, the level of support of European integration drastically fell in Turkey, from over 66% in 2013 to 40% in 2014. Thus, the bilateral negotiations have not yet been renewed, and the future of this process remains very doubtful taking into account the current relations between the European Union and Turkey with regard to the issue of Turkey’s accession (see Strielkowski and Glazar, 2014). Another important aspect to be noted in the context of the current state of Turkey-EU relations is the negotiations on the issue of visa liberalization. Despite of the fact that the visa liberalization process has long been promoted by the European Union as a key stage of deepening of bilateral cooperation with Turkey, as of today, the EU has not yet cancelled the visa regime for the Turkish population. The official negotiations between the EU and Turkey were launched in 2012, but have not much progressed since then. This is further adding to the tensions in the bilateral relations between the European Union and Turkey, and contributes to further slowdown in the process of Turkey’s accession to the European Union. The latest achievement in this field is the readmission agreement signed between Turkey and the European Union in 2013, and the so-called Roadmap towards the visa-free regime. As of today, those documents are rather declarative, but they should play an important role in the visa liberalization process in the near future (see Strielkowski and Glazar, 2014). Having investigated the key milestones in the development of Turkey-EU bilateral relations in the field of Turkey’s accession to the European Union as a full-fledged member, and the current state of those relations, in the next section of our paper, we would like to analyze in detail the advantages and disadvantages that the accession to the European Union may in the long run give to Turkey.

3. ADVANTAGES AND DISADVANTAGES OF TURKEY ACCESSION TO EU: AN EMPIRICAL MODEL As Turkey has long been seeking the status of member state in the European Union, it is important to define the key driving factors which promote the country’s authorities’ desire to achieve membership in the EU, even despite of the constant refusals on the part of the Union. Obviously, the Turkish political leaders believe that accession to the European Union would provide the country with great benefits, and would allow further strengthening its economic development, national security, etc. Cooperation with the European Union is definitely important for Turkey in both economic and political terms, and therefore completion of the integration process is considered to represent a great opportunity to build up even further deeper ties mutually beneficial to both sides. In this section of our paper, we would like to investigate in detail the potential advantages and disadvantages of Turkey’s accession to the European Union. We will analyze those factors from the perspective of different vectors of the Turkey-EU relations in order to discover how different processes can affect different fields of Turkey’s economy, politics, and social sphere. We will also compare the prospective advantages and disadvantages of Turkey’s completion of the European integration process for the purpose of evaluating the real outcome of the country’s potential accession to the European Union as its full-fledged member.

3.1 Research hypotheses Based on the literature review and analysis of Turkish-EU relations, the following research hypotheses have been formulated: – Hypothesis #1: The accession to the EU provides Turkey with access to new markets, and is aimed to build a strong economic relationship between Turkey and the EU in the long run.

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30

– Hypothesis #2: Turkey plays a fundamental role as a bridge to the Muslim world, also in the relationships between the EU and African and Asian countries. – Hypothesis #3: Accession to the EU will ensure free movement for Turkish workers, which might be a solution to the aging problem in the EU. – Hypothesis #4: There is a strong relationship between economic growth and Foreign Direct Investment (FDI), thus the accession to the EU will provide Turkey with a substantial inflow of FDI to its economy.

Further down this thesis, I will attempt to verify or to reject these hypotheses based on the analysis of the available research literature, statistical sources and own implications and rea- soning. In addition, I will run an econometric model of the interdependence of economic development in Turkey and FDI to test for the causality and make implications for the case of Turkish EU accession.

3.2 Advantages of Turkey’s Accession to the European Union When investigating the advantages of Turkey’s potential accession to the European Union, it should be understood that the European integration processes are differently vectored and are not limited only by one sphere of mutual relations. Therefore, for the purposes of my thesis, I would like to analyze those advantages in three key fields: economic, political, and social. This would allow drawing comprehensive conclusions with regard to how European integration may affect the Turkish state as such, its economic development and geopolitical sovereignty, the wealth and national identity of the population, etc.

Figure 1. European Union’s share in Turkey’s exports, as of 2013

EU 41,50%

Other countries 58,50%

Source: Turkish Statistical Institute (2014)

First of all, it is worth analyzing the economic side of the European integration’s positive effects for Turkey, as national economy is the basis for any state’s political independence and high positions in the international arena. Here, it is worth understanding that Turkey has well- developed international relations with the European Union, and the mutual cooperation between them is very advantageous to the country, and holds a very high place in its activities. As we can see from Figure 1 above, the European Union in aggregate accounts for over 40% of Turkey’s total exports. Such a high share of the EU testifies that it is a major partner ensuring a significant part of Turkey’s total income generated from its foreign trade activities. Turkey mainly exports textiles and clothing, and also household appliances, motor vehicles, and other groups of products. Even though Turkey’s exports to the European Union are already large as of today, those figures can even further be increased in the case of Turkey’s completion of the European integration process. In case Turkey finally obtains membership in the European Union, the country will be granted even larger access to the European markets. Turkish produc- 11

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 ers of different goods will obtain greater opportunities to expand their activities to the European market thanks to their lower prices as compared with the average EU level. The low prices combined with high quality are the key competitive advantage which may help promote Turkish goods among European customers. For instance, products of the textile sector or agriculture in Turkey have a high level of quality, and therefore can successfully compete with the European ones in case of the total elimination of all barriers. Moreover, Turkish producers would be able to participate in the various economic development programs and sector initiatives promoted within the framework of the European Union’s economic development. Also, subsidies granted to European manufacturers would be proportionally distributed among Turkish producers as well. Thus, Turkey’s accession to the European Union would provide the local companies with greater access to funds both as subsidies and loans, which would significantly ease the funding process, and would raise the capital of Turkish companies (see Tocci, 2011).

Figure 2. Dynamics of the European Union’s share in Turkey’s exports (in %) 70,0 58,1 60,0 56,6 56,3 56,5 48,3 50,0 46,4 46,5 46,2 41,5 39,0 40,0

30,0

20,0

10,0

0,0 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004

Source: Turkish Statistical Institute (2014)

Figure 2 above illustrates the dynamics of the European Union’s share in Turkey’s exports in the period from 2004 to 2013. As we can see from the chart, the recent dynamics have shown decline as compared with previous years. Eventually, such a decline in the European Union’s total share in Turkey’s exports correlates well with the slowdown in the Turkey-EU negotiations for Turkey’s accession to the European Union. Still, the share of 41.5% is very high, and therefore it testifies the great prospects Turkey would have in economic terms in case the country officially joined the EU. An important characteristic of the Turkish economy is the role of the agricultural sector in the overall employment and formation of GDP in the country. However, even despite of the sector’s crucial role for the Turkish economy, the level of technologies used in agricultural production is rather low and obsolete, due to which the extensive use of resources leads to the deterioration of their quality, and thus lower yield generated from their use. There have already been offers from the European Union to provide subsidies to the Turkish state for the purpose of re- storing and further raising the quality of arable lands, but they have not yet been implemented (see Cengiz and Hoffmann, 2013). If Turkey was a full-fledged member of the European Union, the country’s farmers could effectively participate in all of the EU’s agricultural sector programs, which would allow not only preserving the quality of natural resources, but also further promoting their intensive use. Also, similarly to the industrial producers, companies in the agricultural sector would gain access to finance from the European funds, which would make it possible for

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 them to generate higher profits through the use of new technologies, and thus intensification of production. As one can see from Figure 3, the European Union is also a major partner for Turkey in terms of imports. Overall, the EU’s share in Turkey’s import is 36.7%, which testifies that Turkey is much dependent on the European products. This is predefined by the close geographical location, great logistics, high quality of European goods, and the openness of the Turkish market. On the one hand, Turkey’s accession to the European Union would lead to further greater openness of the country’s domestic market to powerful European corporations, which would definitely represent a considerable threat for smaller local companies. However, at the same time, this would ensure greater competition, and thus greater level of customer service (see Mul- hearn, 2008).

Figure 3. European Union’s share in Turkey’s imports, as of 2013 EU 36,70%

Other countries 63,30%

Source: Turkish Statistical Institute (2014)

Also, it is worth understanding the social aspect of advantages in this respect. In case of Turkey’s membership in the European Union, the local population would gain full-scale access to the high-quality European goods at lower prices. This would be a major advantage for the population in terms of the ratio between quality and prices, and people would definitely win from such accession in this respect (see Arikan, 2006).

Figure 4. Dynamics of the European Union’s share in Turkey’s imports (in %) 60,0 49,3 50,0 45,2 42,6 40,2 40,3 38,0 39,0 40,0 36,7 37,1 36,9

30,0

20,0

10,0

0,0 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004

Source: Turkish Statistical Institute (2014) Figure 4 demonstrates how the European Union’s share in Turkey’s imports changed in the period from 2004 to 2013. As we can see, those dynamics are very similar to the ones existing in the filed of Turkey’s exports to the EU, and in my opinion, they are as well connected with the 13

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 overall deterioration in the relations between Turkey and the European Union due to the slowdown in the negotiations process.

Table 1. Structure of foreign direct investment inflow to Turkey, as of 2012

Rank Country Share in FDI inflow 1 United Kingdom 19,80% 2 Austria 14,70% 3 Luxembourg 12,40% 4 The Netherlands 11,70% 5 Germany 5,40% 6 Malaysia 4,50% 7 Switzerland 4,50% 8 The United States 4,30% 9 Azerbaidjan 3,30% 10 Lebanon 3,10%

Source: Turkish Statistical Institute (2014)

Table 1 above shows the Top 10 countries in the structure of foreign direct investment inflow to Turkey in 2012. As we can see from the data presented in the Table, the first five positions in this ranking are held by EU member states, which in aggregate account for 64% in the total FDI inflows to the country. This shows how much Turkey is dependent on the European Union in terms of the investment placed in the country’s national economy. It is worth understanding that foreign investment is a prerequisite for the effective functioning of the Turkish economy, as this source of funding allows implementing large-scale projects both in the public and private sectors, significantly raising the level of employment through creating new jobs, and overall boosting the economy through the implementation of innovative projects. In case of Tur- key’s accession to the European Union, the country’s legislation would be fully harmonized with the regulations and standards of the EU, and therefore European corporations would not only get guarantees of their trouble-free activities on the Turkish market, but would also get substantially eased conditions of doing business. This would undoubtedly raise their interest in the Turk- ish market, and therefore would promote further increase in foreign direct investment flows from the European Union could be expected (see Tocci, 2011). Turkey’s accession to the European Union would be likely to lead to the country’s participation in the Eurozone, and thus substitution of its national currency with the single European currency, the euro. The Turkish lira itself is much more vulnerable to negative external effects in terms of the exchange rate fluctuations, as all such fluctuations to a large extent depend on the country’s powerful economic basis. The euro is backed by the European Union’s stable economic background and well-thought financial and economic policies implemented on the level of the EU’s governing bodies. Therefore, in case of its accession to the Eurozone, Turkey would be less vulnerable to the financial market shocks, and the stabilization of the national currency’s exchange rate would overall contribute to the faster and more stable development of the country’s national economy (see Massai, 2011). Taking into account how hard the 2008 global financial and economic crisis struck the Turkish economy, it is also worth understanding that the country’s accession to the EU would provide it with a far more stable ground in terms of its financial and economic condition. For

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 instance, the example of Greece shows that, when the country stood on the verge of default due to the disastrous consequences of the 2008 global crisis, the other EU member states in fact saved it thanks to the bailout plans provided by the efforts of all EU countries. In case Turkey hadn’t been member of the EU back then, the country would have inevitably fallen into default, and would have faced economic collapse. Therefore, if Turkey in the long run joins the European Union as its full-fledged member, the country will be protected against negative economic effects of global crises thanks to the fact that the EU member states implement reallocation of funds depending on each country’s current financial conditions and need for assistance. This would be important in order to provide the local economic subjects with higher confidence in the national economy’s stability, and thus to promote their more efficient activities on both the domestic and foreign markets (see Wendicke, 2008). Another particularly important aspect of Turkey’s integration to the European Union is the issue of energy security. As Turkey’s economy is much dependent on energy, and has an ever- growing need in power resources, it would be important for Turkey to ensure a stable source of energy supplies. Within the European Union, its member states tend to implement large-scale policies destined to reach a higher level of energy security. Namely, such policies include diversification of power sources and power suppliers, and promotion of the use of alternative energy. Turkey’s participation in the European Union’s energy programs would obviously provide the country with great opportunities to reach a higher level of energy security, thus ensuring unin- terrupted energy supplies for both the needs of its manufacturers and population (see Boomgaarden and Wüst, 2012). The field of national security is another important sphere of Turkey’s existence and activities which could win significant advantages from the country’s accession to the European Union. Al- though Turkey has long been member of NATO, and thus has been participating in the collective security programs implemented in the EU member states within the framework of NATO’s activities, Turkey’s accession to the European Union would help even further increase the level of the country’s national security, and reach its higher integration with the European states in terms of the military power. This is important for the purpose of ensuring Turkey’s stable geopolitical positions as the leader among the Middle Eastern states. The collective security mechanisms implemented within the framework of the European Union would provide Turkey with even greater protection against all possible external threats (see Strielkowski and Glazar, 2012). An important disadvantage of Turkey’s current relations with the European Union is that the visa-free regime has not yet been implemented for the Turkish people wishing to voyage to the EU. Due to this, the liberty of their movement is restricted, as traveling to the European Union currently requires substantial amounts of funds to be spent. In case of Turkey’s accession to the European Union, the free movement of people across borders within the European Union would be granted. On the one hand, this would be beneficial to the Turkish people, as their expenses for traveling abroad would be reduced, just as the technicalities of the process. On the other hand, this would also allow significantly raising the social mobility of Turkish employees, and thus reducing the overall level of unemployment in the country. For instance, Turkish employees and unemployed people would become able to seek jobs in the European Union without any restrictions, thus freeing a number of vacancies in the country which could be filled with other local workers. At the same time, the wealth of such people would rise, as they would become able to find better-paid jobs in the European Union (see Hale and Ozbudun, 2009). Next, in social terms, it is worth noting that, with Turkey’s accession to the European Union, the Turkish people would obtain a far easier and wider access to the European sector of education services, thanks to which they would get better education, and again, this would raise the overall level of social capital mobility. Also, the level of health services in Turkey would win thanks to the implementation of the EU healthcare programs destined to cover the population with a much higher level of medical services provided (see Guerin and Stivachtis, 2011).

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 Finally, it is worth noting that Turkey’s accession to the European Union as its full-fledged member state would allow preserving the principle of secularity currently predominant in the Turkish state, and would significantly limit the impact of political currents promoting the ideas of Islamism. Also, European integration would allow Turkey raising the level of human rights protection, which is currently a substantial issue in the Turkish, which has many times been stressed by the EU authorities in the course of the negotiations with Turkey (see Tocci, 2011). In political terms, Turkey would win thanks to the redistribution of responsibilities between the local and all-European governing bodies. This would allow ensuring a much higher level of transparency in the political activities and decisions implemented on all levels. Also, thanks to the regulation of a wide number of issues from the single center, Turkey would get a great opportunity to reduce the overall level of corruption in the country. The European Union member states constantly hold high positions in global corruption ratings, which is achieved thanks to the wise policies of counteraction to corruption which are implemented within the framework of the European Union’s governing bodies’ activities. Corruption is one of the key threats the Turk- ish economy on the way toward prosperity, and its elimination is one of the top-priority tasks for the purpose of reaching the maximum degree of liberalization of Turkish national economy. In case of the country’s completion of the integration process with the European Union, Turkey would be able to participate in the aforementioned anti-corruption programs, which would obviously allow effectively managing the national programs implemented in this field (see Tekin, 2010). Also, it is important to note that, by joining the European Union, Turkey would be able to implement its foreign policy within the mutual mechanisms of foreign relations applied by all of the EU member states. This would allow significantly raising the country’s levers of impact in the international arena, thus providing it with even higher weight in the eyes of both its partners and competitors. The synergic effect reached through the implementation of such common foreign policies would allow gaining substantial benefits not only in political, but also in economic terms, which would bring significant yield to Turkey’s national economy (De Vreese, Boomgaarden, and Semetko, 2008). Thus, overall, it can be stated that the advantages of European integration are substantial for Turkey, and therefore it is obvious why the country actively participates in those processes. However, in addition to its benefits, Turkey’s completion of its European integration processes would also represent considerable threats for the Turkish state in different respects, which is predefined by the negative aspects and disadvantages of European integration. In the next chapter of my thesis, I would like to focus on the issue of disadvantages of Turkey’s accession to the European Union as its full-fledged member state for the purpose of evaluating the prospective aggregate outcome of European integration for Turkey.

3.3 Disadvantages of Turkey’s Accession to the European Union When analysing the disadvantages of the European integration processes for Turkey, one should never forget that, although granting high benefits in all fields of mutual relations, such integration processes also have considerable disadvantages which should be thoroughly analyzed in order to understand the overall outcome of the implementation of the European integration scenario for Turkey. Just as the advantages for the Turkish state, the disadvantages of European integration should be investigated as well from the perspective of the various economic, political, and social aspects, in order to understand the complete possible outcomes of the country’s accession to the European Union. As it has already been stated earlier in this thesis, in the economic field, Turkey may significantly benefit from the completion of the country’s European integration process. This is mainly preconditioned by the vast liberalization of economic relations with the European Union, and

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 further greater bilateral openness of the domestic market. Prospectively, such openness allows increasing the overall level of competition in the Turkish economic sector, thus promoting improvement of the goods and services provided to the Turkish customers. However, in reality, liberalization of Turkey’s market for the European corporations represents a potential major threat for the country’s economy. Major European transnational corporations are much more powerful than the local Turkish manufacturers in all respects: they have greater funding, more developed technologies, have large customer bases, and so on. Thanks to this, they are able to gain significant benefits on the economies of scale. If such corporations obtain a totally free access to the Turkish domestic market, they will have far greater opportunities to conquer it, taking into account the high quality of products offered. Indeed, as it has already been said, Turkey’s products are quite competitive in some fields of the economy such as the industry of textiles or household appliances. However, in other industrial sectors, Turkish companies considerably lag behind the European Union’s leading transnational corporations. Moreover, even in the industry of textiles and household appliances, in case of Turkey’s accession to the EU, European companies would significantly reduce the share of the Turkish manufacturers on the domestic market thanks to the enlargement of the range of products offered to the population. Potentially, that could lead to the closure of part of Turkish enterprises (especially on the sector of small and medium enterprises), and thus to the overall deterioration of the economic conjuncture in the country (see Voigt, 2008). Moreover, it is quite doubtful whether Turkish manufacturers would be able to effectively compete on the European market with major European producers of different types of goods. As of today, only the products of the textile industry manufactured in Turkey indeed look prospectively competitive on the European Union’s market thanks to their great quality-to-price ratio. However, products manufactured in other spheres of the Turkish economy are much less competitive, and would most often lose to the European analogues in terms of both price and the level of quality. Due to this, Turkish products would be likely to lose competition to the goods offered by European corporations on both the domestic Turkish market and markets of the European Union’s member states. In this case, this would mean closure of jobs for the Turkish population and substitution of local production by imports from the European Union. The Turk- ish budget would also lose due to the decrease in taxes paid in this case (see Tocci, 2011). Next, it is worth understanding that, in case of Turkey’s accession to the Eurozone, the country would have to adopt the euro in replacement for the Turkish lira as its only official currency. On the one hand, the Turkish lira is much more volatile and dependent on external market conditions than the euro, and is overall much more vulnerable to all possible shocks, so the adoption of the euro could be regarded as positive. However, on the other hand, the adoption of the euro would mean that Turkey would be deprived of a number of its own significant monetary mechanisms to a large extent predefining the country’s ability to effectively manage its national economy. The monetary supply in Turkey would be completely dependent on the European Cen- tral Bank, and that would bring Turkey to a large economic and financial dependence on the European Union (see Tekin, 2010). The 2008 global financial and economic crisis showed that crisis in the Eurozone is inevita- ble, if one of its countries undergoes hard times, and the exchange rate of the euro tends to gradually fall in those circumstances. A country with its own national currency has much wider opportunities to regulate its exchange rates using the national reserves, letting the exchange rate flow, purchasing or selling currencies through public institutions, and so on. In the Euro- zone, one country’s failure to comply with the established principles and standards leads to a chain reaction of negative events to the rest of the Eurozone countries. Therefore, it can be said that, in case of Turkey’s accession to the European Union, the country would definitely lose part of its sovereign mechanisms implemented in order to regulate tits monetary policies, and thus its economic development in general (Yesilada, Rubin, and Rubin, 2013). 17

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 In the financial sector, Turkey would be forced to participate in the common financial policies implemented by the European Union member states. Namely, Turkey would be forced to participate in the bailout plans mutually provided to those European States which are undergo- ing periods of deep stagnation, and therefore require substantial funds on the part of their EU colleagues. This would be ineffective for Turkey, since, as of today, the country’s economy is self-sufficient, and can cover well all its internal needs. Therefore, it would be likely to remain stable, and wouldn’t require assistance from the EU. To the contrary, countries such as Greece or Portugal survive harsh times, and overcome the consequences of the 2008 global financial economic crisis, and therefore they would be more likely to demand assistance from other European member states, and namely from Greece. The allocation of such resources to other states would be detrimental to the Turkish economy, and would make the state spend much more on the bailout plans, without being able to focus such resources on the needs of the local population (Guerin and Stivachtis, 2011). In the financial sector, the Turkish economic subjects could get access to cheaper bor- rowed funds, which would seemingly be beneficial to the Turkish companies, but would in fact represent another major threat for its national economy. For instance, cheaper loans which would become available to Turkish companies in the case of the country’s accession to the European Union as its full-fledged member would potentially be very dangerous, which is testi- fied by the example Greece. Both the Greek public and private sectors used to overuse loans. The 2008 global financial and economic crisis placed the country of the verge of economic bankruptcy and political default. In case of Turkey’s accession to the European Union, the same risk would also exist in the context of overuse and the subsequent inability to repay such loans on the part of Turkish companies (see Mulhearn, 2008). In case of Turkey’s accession to the European Union, the visa-free regime would be established between Turkey and the European Union for all transborder movements of people. In this case, there would be a threat that Turkish corporations would far more often use European workforce, namely for high managerial positions, due to their experience and powerful professional background. This would definitely be a negative process for Turkey’s employees which would thus be forced either to seek jobs on less important positions and with lower wages, or even would be left with any job at all. Moreover, migration processes from countries such as Greece, Bulgaria or Romania, i.e. those EU member states which are not more developed than Turkey in economic and technological terms, would mean possible use of such foreign workforce as regular employees on many Turkish enterprises. This would bring to increased unemployment, and therefore not only to the deterioration of the Turkish population’s living standards, but also to increased state budget expenditures, namely for the payment of unemployment benefits (see Wendicke, 2008; Bilan, 2014). Another major problem is social terms is the possible relocation of part of the refugee camps in the European Union to the territory of Turkey. This would potentially represent a major threat to Turkey’s social sector, as the country would become a site of inflow of refugees. This would increase the tensions inside the Turkish society, and could also lead to an increase in the level of crimes in the country. Moreover, this would inevitably lead to increased government expenditures directed to the struggle against such crimes and payment of costs associated with the maintenance of the new refugee camps (see Tocci, 2011). Also, the opened borders for the movement of people would probably lead to an increase in the outflow of highly qualified specialists from Turkey to the European Union, and namely to the so-called brain-drain processes. Turkish specialists in different fields would get an opportunity to find better paid jobs on the territory of the EU, and would therefore seek to leave Turkey for the purpose of gaining higher earnings. This would not only deprive Turkey of qualified profes- sionals, but would also lead to an overall poorer situation with scientific development, research and engineering activities run in the Turkish national economy (see Arikan, 2006).

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 Next, it is important to understand that the completion of Turkey’s process of integration to the European Union would deprive Turkey of further opportunities to participate in any integration alternatives available in the Asian region. For instance, Turkey could potentially follow the vector of integration within the framework of the Shanghai Cooperation Organization together with the world’s superpowers such as China and Russia. This would potentially be a great alternative for Turkey’s economic and political development taking into account the close geographical location of Asian states involved in SCO. However, in case that Turkey finally completes its accession to the European Union, the country would have to ultimately abandon those alternative integration scenarios. This would lead to the deterioration in relations between Tur- key and the Asian states. In this case, Turkey would be more likely to lose its leading positions in Asia to China and other regional leaders. Loss of Turkey’s geopolitical influence in the Asian region would be much vulnerable to the country’s overall positions in the international arena (see Boomgaarden and Wüst, 2012). Finally, it is important to understand in geopolitical terms that the EU promotes peaceful resolution of the issue with Kurdish separatist movements on the territory of Turkey. As the EU stresses the need to resolve this issue, it is quite possible that, with Turkey’s accession to the European Union, the EU would impose liabilities on the Turkish state to hold a referendum on Kurds’ independence, with the separation of their territories from the sovereign lands of Turkey, as the EU promotes to the largest extent the principle of self-determination of nations. Of course, such a scenario of resolution of the issue with separatist Kurdish movements would undoubtedly be inappropriate for Turkey, and this could provoke major conflicts already within the European Union (see Akçapar, 2007). Also, with Turkey’s accession to the EU, the intensification of Islamist movements could be expected, as the official accession to the European Union would mean further secularization of the Turkish state, and thus would lead to the suppression of movements promoting the establishment of the sharia laws on the entire territory of the country. This situation could provoke mass riots and street clashes between the supporters of Islamists and the supporters of Euro- pean integration. Such protests could be supported and promoted by Islamist Asian states, which could even further destabilize the situation in Turkey. This should be taken into account, as such protests would require immediate and effective counteraction, and would probably im- ply significant economic consequences (see Tocci, 2011). Overall, when evaluating the advantages and disadvantages of Turkey’s prospective completion of integration process with the European Union, it is worth understanding that all and any integration scenarios assume both positive and negative effects, and there are no purely beneficial or disadvantageous integration alternatives due to the very essence of the integration processes. Thus, it is worth comparing the positive and negative outcomes of European integration for Turkey in order to understand the aggregate effects Turkey’s accession to the European Union as its full-fledged member could bring to the country. In our opinion, based on the findings of my analysis, it can definitely be said that the Euro- pean integration alternative is definitely beneficial to the Turkish state in the context of comparison between the possible positive and negative effects. The economic, political, and social advantages potentially provided by the European Union to Turkey in the case of the country’s ultimate accession to the EU excess the possible risks incurred by Turkey to the completion of this integration scenarios, and therefore it can obviously be stated that continuing the ongoing negotiations with the European Union for the provision of membership status to Turkey is an important task of Turkey’s foreign politics. By joining the European Union as its full-fledged member, Turkey would get an opportunity to significantly boost its economic development thanks to the far greater openness of the European member states’ markets. Moreover, Turkey would be able to grant its energy security in the long-term period through the participation in mutual energy security programs. Collective security mechanisms implemented within the framework of cooperation in the European Union would allow granting a higher level of the 19

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 country’s national security. Finally, thanks to the accession to the European Union, Turkey would be able to further strengthen its geopolitical positions in the international arena.

4. RESULTS OF HYPOTHESES TESTING Hypothesis 1 can be confirmed. Indeed, Turkey’s potential accession to the European Union will be likely to provide the country with great opportunities in economic terms. Namely, the completion of the country’s integration process with the EU would allow Turkey obtaining a far larger and easier access to the EU member states’ markets which are currently inaccessible due to Turkey’s position as a non-member of the Union. Due to this, the country doesn’t have free access to all markets, and is still subject to restrictions and limitations which are eliminated within the European Union. By gaining wider access to the European markets, Turkey would obviously become able to further deepen its cooperation with the European Union, thus building up closer partnership ties with the EU member states in terms of their mutually beneficial economic relations. Also, this would ease the inflow of investment to Turkey, as European investors would become more confident in the creditworthiness of the country being a member state of the European Union. However, it should be understood here that, together with the advantages for the Turkish economy, the country’s integration with the EU would also impose considerable threats on its economic sector. Thus, the European manufacturers would gain far wider access to the Turkish market as well. As European corporations are much more powerful than the Turkish ones, and have larger financial resources, they would have much more effective levers to affect the competition on the Turkish domestic market through both price and non-price mechanisms. Therefore, this would pose under threat the Turkish local producers’ effective market results, as they would have to face much more powerful competitors than before. Moreover, it is quite doubtful whether Turkey would be able to benefit so much from the wider openness of the European markets. This is mainly preconditioned by the fact that Tur- key’s manufacturers’ products are generally weaker in terms of their quality and competitiveness than the same products offered by EU member states’ residents. Thus, in case of Turkey’s accession to the EU, there would be a major threat that most Turkish companies would lose competition on the domestic market, at the same time being unable to establish themselves as popular brands on the markets of the EU member states. Hypothesis 2 can be confirmed. Indeed, Turkey is a bridge between the European Union and the Muslim world, and the country will be likely to pay a great role in the cooperation between the EU member states and the Muslim Asian and African countries, especially in case of Turkey’s accession to the European Union. Turkey is an interesting example of an Islamic country which is completely secular and deprived of all signs of Islamism which is prosecuted, Turk- ish society is highly liberal and democratic, and the religion doesn’t interfere in the field of public affairs. This is particularly important for building up close partnership ties with the European Union, and the European society doesn’t accept any king of discrimination, especially when speaking of religion, and the practice of use of religion is state management is not welcomed in the Union. At the same time, in the Islamic world, cooperation between countries with the population sharing Islam tends to be much wider and much more effective than with countries where other religions are prevailing. This is a key factor of Turkey’s successful relations with Northern African Arab states. At the same time, Turkey’s geographical location between Europe and Asia allows the country effectively cooperating with the Asian states. Thanks to its unique expertise, Turkey would be able to profit much from its ties with both the Islamic world and Asian countries in the process of its integration with the European Union. This is predefined by the fact that the EU currently seeks greater economic expansion, and sees the Asian and North African markets as prospective growth areas which can be effectively filled by European companies. Turkey’s involvement in those processes would allow not only further strengthening ties with all parties, but also gaining significant financial dividends.

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 Hypothesis 3 can rather be rejected. The free movement of labour within the European Un- ion would definitely provide Turkish workers with an opportunity to move freely within the EU member states for the purpose of finding vacancies on the European labour market. As the greatest part of the workforce travelling abroad in search for better living or working conditions are young people, the greater inflows of workers from Turkey to the European Union would obviously be constituted by younger people, and therefore this would contribute to a change in the age structure of the EU. Such change would thus represent a tendency toward decline in the median age of the European citizens. However, it is worth understanding here that the number of people migrating from Turkey would not be so high against the background of the total population of the European Union. Therefore, the young migrants from Turkey would be “dissolved” in the great European population, and the aforementioned changes in the overall age structure of the EU wouldn’t be substantial. Therefore, this wouldn’t help resolve the issue of ageing of the population neither in the short-term, nor in the long-term. Moreover, in my opinion, this problem can only be eliminated through the implementation of wise economic, social and demographic policies on the all-European level, and immigration cannot be an effective solution in this case. After all, it is worth understanding that, even if minor positive effects can be reached thanks to the inflow of immigrants in the short-term period, already in the mid-term perspective, the problems currently existing in the social and demographic fields will again ne- gate all such positive advancements. Hypothesis 4 can be neither confirmed nor rejected. On the one hand, there is indeed a strong relationship between the level of a country’s economic development and the inflow of investment to it. On the other hand, it can definitely be stated that the level of foreign direct investment to Turkey would increase in case of its completion of the European integration process. However, this would be caused by a number of different reasons, in the first turn this would be achieved through the ease of investors’ access to the Turkish market, and their higher confidence in the successful results of their business in Turkey. However, it may be achieved even without economic growth. At the same time, the correlation between the two indicators above, namely economic development and FDI, is not so obvious in order to say that Turkey’s accession to the European Union would provide the country with greater foreign direct investment thanks to its economic growth within the EU. This hypothesis can be justified through Table 3 and Figure 5 below.

Table 2. Correlation between Turkey’s economic growth and FDI inflows in 2003-2013

Year GDP per capita (thousand current USD) FDI inflow (billion current USD) 2003 8,8 1,7 2004 10,16 2,79 2005 11,39 10,03 2006 12,91 20,19 2007 13,88 22,05 2008 15,02 9,76 2009 14,55 8,63 2010 16 9,06 2011 17,78 16,17 2012 17,97 13,22 2013 18,81 12,87

Source: Own results based on materials of the Turkish Statistical Institute and the World Bank (2014) As one can see from the information given on the charts above, in the period from 2003 to 2013, the curve of Turkey’s GDP per capita which serves as the best index of the country’s economic growth remained mainly positive, while the curve of foreign direct investment didn’t have 21

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 any prevailing tendency throughout the analyzed period. Thus, the highest values of FDI inflows to Turkey were reached in 2006-2007 when those figures made up over 20 billion US dollars per year. However, afterwards, there was another peak, and again a decline in 2012-2013. This is in contrast to the indexes of economic growth shown during the same period which only tended to increase. Thus, for instance, as we can see from Figure 4 above, in 2012, the gap in correlation between GDP per capital and FDI inflows only widened, as those indicators showed differently vectored tendencies of changes. Thus, it can obviously be stated that the level of FDI inflows to Turkey in the analyzed period was predefined not only by the country’s level of economic growth, as investors may be interested in funding economies in a condition of slowdown, and may refrain from investing in economies currently showing a high growth level. Therefore, it cannot be definitely stated whether Turkey’s economic growth would indeed lead to increase in FDI after the country’s accession to the European Union. However, in this case, Turkey’s economic growth would definitely contribute to such increase, even though probably indirectly, while the greatest role would be played by Turkey’s ability to attract investors using various economic and other means.

Figure 5. Correlation between Turkey’s economic growth and FDI inflows in 2003-2013

GDP per capita 15 (thousand current USD) FDI inflow (billion current 10 USD)

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Turkish Statistical Institute (2014); World Bank (2014)

In order to test more deeply the hypothesis about the interconnection between Turkey’s prospective accession to the European Union and the increase of foreign direct investment inflow to the country, the author has built the following econometric model:

lg (real gdp i) = α + β1·lg (fdi i) + β2·lg (inf i) + β3·lg (emp.rate i) + β4·lg (trd i) + β5·lg (rem i) + ε (1)

where: real gdp i - the real value of Turkey’s GDP

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 fdi i - foreign direct investment (expressed in $) inf i – inflation (in %) emp.rate i - employment rate (in % to the population) trd i - volume of trade expressed in $ rem i - remittances received by Turkish households (in $) We assume that the level of Turkey’s GDP is a constant, and its value is determined by the levels of independent variables. Based on the research literature and on the theory, we assume the following impacts of the right-hand variables on the left-hand dependent variable: foreign direct investment (positive impact), inflation (negative impact), employment (positive impact), trade (positive impact), and remittances (negative impact). Most econometric models measure growth explained by the stochastic growth models. Sto- chastic growth models are the modification of basic growth models with incorporated random shocks (in order to understand business cycles), such as technological progress, shock on the supply or demand side, etc. The best example of a stochastic model on the macro-level is the stochastic version of the Cass-Koopmans model (Romer, 2001). Stochastic growth models (the best example on the micro-level is Gibrat’s Law) are characterized by the following features: (i) macro and/or aggregated dynamics of the model, and (ii) no fluctuations. Their basic aim is to reproduce observed power-law distributions, derive growth dynamics, and allow for the fitting of real data. The traditional outlook of any stochastic growth model is presented as a model with two de- terministic components (exogenous growth and endogenous growth) and one stochastic component (random growth term ε). A model such as Gibrat’s Law (the Law of Proportionate Effect) expressed in terms of a stochastic model has two basic assumptions: (i) log is normally distributed and is independent of the observation size; and (ii) the mean proportionate growth of a group is independent of the initial size.

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30

Table 3. Econometric model for Turkey

Real Employment rate Remittances growth FDI Inflation Trade Year Real GDP (in $) (in % to popula- received (GDP) (in (in $) (in %) (in $) tion) (in $) %) 1998 2,3 194 216 437 976,9 940 000 000 138,0 48,3 111 802 523 974 5 356 000 000 1999 -3,4 187 680 386 832,2 783 000 000 54,2 47,7 96 718 447 947 4 533 000 000 2000 6,8 200 394 710 743,7 982 000 000 49,2 45,6 115 136 236 404 4 560 000 000 2001 -5,7 188 977 269 251,5 3 352 000 000 52,9 44,5 99 484 898 009 2 786 000 000 2002 6,2 200 625 525 075,8 1 082 000 000 37,4 43,3 113 477 057 458 1 936 000 000 2003 5,3 211 188 991 344,8 1 702 000 000 23,3 42,0 142 511 629 689 729 000 000 2004 9,4 230 962 210 199,1 2 785 000 000 12,4 41,0 195 052 433 532 804 000 000 2005 8,4 250 366 772 494,1 10 031 000 000 7,1 41,2 227 999 711 968 887 000 000 2006 6,9 267 625 779 260,4 20 185 000 000 9,3 41,2 266 782 374 519 1 146 000 000 2007 4,7 280 120 101 291,1 22 047 000 000 6,2 41,1 322 329 293 115 1 248 000 000 2008 0,7 281 965 640 210,3 19 762 000 000 12,0 41,4 381 591 082 597 1 476 000 000 2009 -4,8 268 358 330 269,9 8 629 000 000 5,3 40,9 293 377 236 258 1 050 000 000 2010 9,2 292 931 776 183,9 9 058 000 000 5,7 42,7 350 733 417 820 993 000 000 2011 8,8 318 629 941 593,0 16 171 000 000 8,6 44,6 438 697 599 940 1 087 000 000 2012 2,1 325 408 668 119,6 13 222 000 000 6,9 44,9 455 606 702 394 1 015 000 000 2013 4,1 338 829 122 004,1 12 918 000 000 6,1 44,5 475 621 740 677 919 000 000

Source: Own results

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 Evans (1987) used a modified version of this model, stating that the departures from Gi- brat’s Law. Evans’s model became an inspiration for the other few researchers. For instance, in their paper on investments, inputs and economic growth, Variyam and Kraybill (1994) began with the model presented by Evans (1987). They first estimated the regression model developed by Evans without the squared and cross product terms, and tested for nonlinearities implied by these terms using Theil’s BLUS residual tests. Then they estimated several model extensions that have additional sources of heterogeneity in growth rates.

Table 4. Econometric model for Turkey: weight of the factors

1,00000 2,00000 3,00000 4,00000 5,00000

1998 0,00071 -0,03194 0,23419 0,19854 -0,08281 1999 0,00061 -0,01298 0,23933 0,17773 -0,07253 2000 0,00072 -0,01105 0,21428 0,19816 -0,06833 2001 0,00261 -0,01258 0,22175 0,18156 -0,04427 2002 0,00079 -0,00839 0,20324 0,19508 -0,02898 2003 0,00119 -0,00496 0,18728 0,23273 -0,01037 2004 0,00178 -0,00241 0,16717 0,29127 -0,01045 2005 0,00590 -0,00127 0,15496 0,31408 -0,01064 2006 0,01110 -0,00157 0,14497 0,34380 -0,01286 2007 0,01159 -0,00100 0,13817 0,39686 -0,01338 2008 0,01032 -0,00191 0,13826 0,46675 -0,01572 2009 0,00473 -0,00089 0,14352 0,37704 -0,01175 2010 0,00455 -0,00087 0,13727 0,41294 -0,01018 2011 0,00747 -0,00121 0,13181 0,47485 -0,01024 2012 0,00598 -0,00095 0,12993 0,48288 -0,00937 2013 0,00561 -0,00081 0,12368 0,48413 -0,00814

0,00473 -0,00592 0,16936 0,32678 -0,02625

0,00473 0,00592 0,16936 0,32678 0,02625

0,00887 0,01111 0,31773 0,61304 0,04925

0,00004 -0,00007 0,05381 0,20033 -0,00129

0,25282

Source: Own results

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 Table 5. Econometric model for Turkey: values of the factors

lg lg lg lg lg lg Real GDP FDI Inflation Employment rate Trade Remittances (in $) (in $) (in %) (in % to population) (in $) received (in $) 1998 11,29 8,97 2,14 1,68 11,05 9,73 1999 11,27 8,89 1,73 1,68 10,99 9,66 2000 11,30 8,99 1,69 1,66 11,06 9,66 2001 11,28 9,53 1,72 1,65 11,00 9,44 2002 11,30 9,03 1,57 1,64 11,05 9,29 2003 11,32 9,23 1,37 1,62 11,15 8,86 2004 11,36 9,44 1,09 1,61 11,29 8,91 2005 11,40 10,00 0,85 1,61 11,36 8,95 2006 11,43 10,31 0,97 1,61 11,43 9,06 2007 11,45 10,34 0,79 1,61 11,51 9,10 2008 11,45 10,30 1,08 1,62 11,58 9,17 2009 11,43 9,94 0,72 1,61 11,47 9,02 2010 11,47 9,96 0,75 1,63 11,54 9,00 2011 11,50 10,21 0,93 1,65 11,64 9,04 2012 11,51 10,12 0,84 1,65 11,66 9,01 2013 11,53 10,11 0,79 1,65 11,68 8,96

Source: Own results

The results of the econometric model can be summarized by the following equation representing the equation depicted in (1) and amended to show the values of the coefficients:

lg (real gdp i) = 7.172 + 0.009·lg (fdi i) – 0.03·lg (inf i) + 0.685·lg (emp.rate i) + 0.286·lg (trd i) – 0.022·lg (rem i), (2)

Table 7 shows the factors’ effects (the % increase of the independent variables caused by the 1% increase in the dependent variable (real GDP of Turkey).

Table 6. Factors’ effect

Employment 1% ↑ FDI Inflation Trade Remittances rate Real GDP 0.0047% ↑ 0.0059% ↓ 0.1694% ↑ 0.3267% ↑ 0.0263% ↓

Source: Own results

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 The values are computed with respect to the fact that all the variables were expressed in logarithms and therefore need to be re-calculated in order to be expressed in real values. Table 8 shows the consolidated factor effects (a 1% increase of real GDP would lead to the 0.25% increase in the consolidated factor).

Table 7. Consolidated factor effect

1% ↑ Consolidated factor Real GDP 0.2528% ↑

Source: Own results

As one can see from the calculations done for the econometric model for testing the factors predefining the level of Turkey’s GDP, trade has the greatest positive impact on the country’s gross domestic product. Thus, if the figure of Turkey’s trade grows by 1%, the country’s GDP will grow by 0.3267%. Other positive factors include the rate of employment and foreign direct investment. If the rate of employment grows by 1%, Turkey’s GDP will grow by 0.1694%. Respec- tively, if the level of FDI increases by 1%, Turkey’s GDP will grow by 0.0047%. At the same time, in contrast to trade, employment and foreign direct investment, inflation and remittances are negative factors which contribute to the decrease of Turkey’s gross domestic product (Ustubici and Irdam, 2012). Thus, if the rate of inflation grows by 1%, Turkey’s real GDP will fall by 0.0059%. Respectively, if remittances increase by 1%, the country’s real GDP figure will drop by 0.0263%. Based on the results of the above testing, it can obviously be seen that the level of foreign direct investment has positive effects on the Turkish economy. However, it is worth noting that, among the positive factors, the value of foreign direct investment is the lowest. This means that the growth of FDI is not the most essential factor predefining the level of Turkey’s gross domestic product. Moreover, as the figure of foreign direct investment’s impact on GDP is almost equal to zero, this obviously means that the level of correlation between FDI and GDP is quite low. This proves the previous empirical findings of the author’s analysis which showed weak dependence between Turkey’s GDP and the level of foreign direct investment inflow in the country. At the same time, factors such as the rate of employment and trade have a much higher impact on the level of Turkey’s gross domestic product, and their respective values are considerably higher than the ones of foreign direct investment inflow. Therefore, taking into consideration the results of the author’s testing run under the above econometric model, it can be stated that Turkey’s accession to the European Union and the subsequent growth of FDI inflow in the country through the investment of European companies and private investors will not play a major role in the growth of the country’s gross domestic product, and its figure will more largely be predefined by other factors, namely by trade and the rate of employment.

5. CONCLUSIONS AND POLICY IMPLICATIONS Turkey’s process of integration with the European Union started back in the 1960’s, when the country became an associate member of the EU. Since then, Turkey has made many attempts to transform its official status of candidate for membership into the status of full-fledged member of the European community. However, as of today the country has not yet been able to complete its European integration process, and there have lately been declarations of Turkish officials that the country may officially suspend its European integration course. 27

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 On the way toward European integration, Turkey has already implemented a great number of reforms in all fields of its activities. Thus, the Turkish legislation in the economic and social fields has long been unilaterally harmonized with the regulations and standards of the European Union for the purpose of complying with the accession criteria imposed by the EU. In the early 2000s, Turkey implemented a wave of economic reforms destined to improve the country’s economic indicators and financial results in line with the requirements of the European Union. Thanks to the effective results of those economic reforms, Turkey was able to fulfill the Maastricht criteria, and as of today, in economic terms, the country is compliant with the requirements for prospective members. Moreover, in the social field, the country was able to meet the EU’s basic requirements to the protection of human rights and freedoms, and still currently undertakes steps to further improve the situation on this segment. However, the integration process has not recently substantially progressed, which can be explained by objective conditions. A major obstacle on the way of Turkey’s completion of its integration process with the Euro- pean Union is the country’s support of the self-proclaimed Turkish Republic of Northern Cyprus, which is a separatist formation declaring the goal to secede from the sovereign ruling of Cyprus and enter Turkey as its autonomous territory. The self-proclaimed state has as of today been recognized only by Turkey, and it faces heavy opposition of the European Union member states. As Cyprus is a member state of the EU, its antagonistic conflict with Turkey over the territory of Northern Cyprus makes it impossible for Turkey to join the EU. Cyprus blocks all Turkey’s inten- tions to join the EU, and therefore the prospects of integration currently seem to be vague for the Turkish state. Turkey’s prospective completion of the European integration process may potentially provide the country with great economic and security benefits. Thus, by joining the European Union, Turkey would gain free access to the European market of goods and services, and the local manufacturers could benefit from this situation by offering quality goods at prices lower than the European companies. At the same time, the level of unemployment in Turkey could be potentially reduced through migration of Turkish workers to Europe in search for better working conditions. Finally, it is worth understanding that Turkey’s accession to the European Union would provide the country with a far higher level of national security thanks to the participation in collective defense and security mechanisms implemented within the EU. However, the threats represented by Turkey’s accession to the European Union shouldn’t be underestimated. The country’s local manufacturers are weaker than their European competitors, and accession to the EU may lead to closure of many Turkish companies, and thus deterioration of the market conjuncture. Also, cancellation of the national currency in favor of Turkey would deprive Turkey of important economic regulation mechanisms. Finally, Turkey would thus lose its sovereign political levers as part of the national powers would be delegated to the single center in the European Union. Further progress of Turkey’s integration process with the EU will be predefined by many external factors, and as of today, it is hard to forecast whether this process will in the long run be successful. If Turkey successfully completes the aforementioned requirements, its chances for getting EU membership will significantly grow. In case the country is finally able to get the official membership status, its development may follow different vectors, as it has already been stated earlier in this thesis. I believe that, overall, Turkey will get significant benefits from its official membership in the European Union. However, on the first stages after the completion of the integration process, the country will be likely to face some major difficulties connected with the differences in its economic development as compared with the EU. Here, it is first of all worth noting that Turkey will need to substantially update its legislative base for the purpose of meeting the requirements of the European Union, and complying with the European standards and regulations in all fields. This step will be important for the liberalization of the Turkish economy and the effective integration of its domestic market into the 28

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 European single economic space. The change in the legislation will bring challenges to the economic subjects incorporated in Turkey, as they will have to adapt to the new conditions of doing business and the requirements imposed on them. Another major difficulty will be the inflow of European goods which are generally of a higher quality. In my opinion, many Turkish manufacturers will be unable to withstand the competition of major European corporations, and therefore will be eliminated from the market. However, at the same time, companies which will be able to revamp their production processes and market practices will significantly raise their level of competitiveness as compared with the situation existing now. This will increase their market performance, and they will even be able to expand to the European market, provided that they are able to meet the demand of customers with some particular key advantages. After the initial stage of membership in the European Union, namely upon completion of the adaptation process, the Turkish economy will be likely to gain unprecedented opportunities for its subsequent development. Namely, as the conditions of doing business in the country will correspond to the ones existing in the European Union, and the rules applied will be the same as in the EU, European investors will be interested in investing in the Turkish economy for the purpose of developing their business. Thus, Turkey will be able to get a major boost of its national economy through the increased inflow of foreign direct investment. The increased cooperation with the European Union will be likely to provide Turkey with additional vacancies, and thus reduced level of unemployment, through the intensified activities of foreign corporations and the enlargement of the Turkish domestic market. Also, if the country enters the Eurozone, its foreign exchange risks will be significantly diminished, thus contributing to the overall stable situation of the Turkish economy. Another major advantage for Turkey, in case of the country’s accession to the European Un- ion, will be the increased energy security through the energy supply diversification programs currently implemented in the EU. The implementation of such programs in Turkey will be likely to positively impact the level of Turkey’s economic independence and stability. A not less important prospective benefit Turkey will gain, if it joins the European Union, is the country’s participation in the European collective security mechanisms and systems. It will allow significantly increasing the level of Turkey’s national security, and even help further promote the country’s cooperation with its allies within NATO. However, if the time is right and Turkey will be accepted to the European Union, it will have to give up a part of its sovereign powers. Additionally, the country will inevitably fall under the great dependence on the single EU center, which will significantly reduce its possibility to manoeuver in the international arena in both economic and political terms. This may become an important obstacle on the way of the country’s integration with the EU, as the availability of such sovereign powers raises the level of the state’s independence, which would otherwise be diminished.

REFERENCES Akçapar, B. (2007), Turkey's New European Era: Foreign Policy on the Road to EU Membership, Rowman & Littlefield, Maryland. Arikan, H. (2006), Turkey and the EU: an awkward candidate for EU membership? (Vol. 302), Ashgate, Aldershot. Bilan, Y. (2014), “Migration aspirations on the outskirts of Europe: social and economic dimensions”, Transformations in Business & Economics, Vol. 13, No. 2B, 604-614. Bilan, Y. V. (2014), “Social dimension of external migration: theory and practice (cases of Turkey and Ukraine)”, Sotsiologicheskie Issledovaniya, No. 9.

Rashad Gurbanov, Yuriy Bilan, Wadim Strielkowski / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 7-30 Boomgaarden, H. G., Wüst, A. M. (2012), “Religion and party positions towards Turkish EU accession”, Comparative European Politics, 10(2), 180-197. Cabelkova, I., Strielkowski, W., Mirvald, M (2015), “Business influence on the mass media: a case study of 21 countries”, Transformations in business & economics, Vol. 14, Issue 1, 65-75 Cengiz, F., Hoffmann, L. (2013), Turkey and the European Union: Facing New Challenges and Opportunities, Routledge, New York. De Vreese, C. H., Boomgaarden, H. G., Semetko, H. A. (2008), “Hard and Soft Public Support for Turkish Membership in the EU”, European Union Politics, Vol. 9, No. 4, 511-530. Europa. The Founding Principles of the Union (2014), Available at: http://europa.eu/scadplus/constitution/objectives_en.htm#OBJECTIVES European Commission (2013). Candidate and pre-accession countries’ economic quarterly, Available at: http://ec.europa.eu/economy_finance/db_indicators/cpaceq/documents/cceq_2013_q4_ en.pdf [retrieved 14.10.2014 Evans, D. (1987), “The relationship between firm growth, size, and age: Estimates for 100 manufacturing industries”, The journal of industrial economics, 567-581 Guerin, S. S., Stivachtis, Y. A. (Eds.). (2011), On the Road to EU Membership: The Economic Transformation of Turkey, No. 17, ASP/VUBPRESS/UPA. Jiroudková, A., Rovná, L. A., Strielkowski, W., Šlosarčík, I. (2015), “EU Accession, Transition and Further Integration for the Countries of Central and Eastern Europe”, Economics and Soci- ology, Vol. 8, No 2, 11-25. Hale, W., Ozbudun, E. (2009), Islamism, democracy and liberalism in Turkey: The case of the AKP, Routledge, New York. Massai, L. (2011), The Kyoto Protocol in the EU: European Community and member states under international and European law, Springer, Berlin. Mulhearn, C. (2008), The euro: its origins, development and prospects, Edward Elgar Publish- ing, Cheltenham. Romer, D. (2001), Advanced macroeconomics, McGrawHill/Irwin, New York. Strielkowski, W., Glazar, O. (2012), Turkish migration in Europe. Lulu.com, Charles University in Prague, Praha. Strielkowski, W., Glazar, O. (2014), “Turkish migration in Europe: EU accession and migration flows”, Migration Letters, Vol. 11, No. 2, 245-257 Strielkowski, W., Glazar, O., Ducháč, T. (2014), “Economic Implications of Turkish Migration in Europe: Lessons Learned from Polish EU Accession”, Journal of Economic Cooperation and Development, Vol. 35, No. 2, 91-120 Tekin, B. (2010), Representations and Othering in Discourse: The Construction of Turkey in the EU Context, John Benjamins Publishing, Amsterdam. Tocci, N. (2011), Turkey's European future: behind the scenes of America's influence on EU- Turkey relations, NYU Press, New York. Turkish statistical institute, Online. Available at http://www.turkstat.gov.tr/UstMenu.do?metod=temelist. Ustubici, A., Irdam, D. (2012), “The Impact of Remittances on Human Development: a Quantita- tive Analysis and Policy Implications”, Economics and Sociology, Vol. 5, No. 1, 74-95. Variyam, J., Kraybill, D. (1994), “Managerial inputs and the growth of rural small firms”, American Journal of Agricultural Economics, Vol. 76, No. 3, 568-575 Voigt, S. (2008), The Customs Union Between Turkey and the EU: How Did it Affect Turkey? Diplomica Verlag, Hamburg. Wendicke, A. (2008), EU Membership: An Unfeasible Plan for Turkey, Routledge, Berlin. World bank. Online. Available at: http://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD?page=2 Yesilada, B., Rubin, B., Rubin, S. R.. Eds. (2013), Islamization in Turkey under AKP rule, Routledge, New York.

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48

Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 31-48 ‘

Evaluating the Social Infrastructure of Municipalities

Evgeny V. Popov1, Irina S. Katz2, Anna Y. Veretennikova3

1 Corresponding Member of the Russian Academy of Sciences; The head of the Economic Theory Center, Institute of Economics of the Urals Branch of the Russian Academy of Sciences; Professor of the Department "Theory of Management and Innovation", Institute of Public Administration and Entrepreneurship of the Ural Federal Univer- sity named after the First President of Russia B.N Yeltsin; E-mail: [email protected] 2 Researcher in the Economic Theory Center, Institute of Economics of the Urals Branch of the Russian Academy of Sciences; E-mail: [email protected] 3 Researcher in the Economic Theory Center, Institute of Economics of the Urals Branch of the Russian Academy of Sciences; Assistant of the Department “Regional and Municipal Economy, Finance and Security”, Institute of Public Administration and Entrepreneurship of the Ural Federal University named after the First President of Rus- sia B.N Yeltsi; E-mail: [email protected]

ARTICLE INFO ABSTRACT Received June 21, 2015 The present paper sets out to examine the nature and composition Received in revised from Sept. 7, 2015 of the concept of social infrastructure, to assess the spatial acces- Accepted November 27, 2015 sibility of public goods that comprise the social infrastructure of Available online Dec. 03, 2015 urban areas and to formulate hypotheses to account for the influence of a number of different factors on social infrastructural devel- JEL classification: opment. The selection of primary research methods is determined Н41, Н54 by the specific character of studies aimed at assessing the degree of public satisfaction with the spatial accessibility of social benefits, DOI: i.e. an empirical survey of respondents combined with statistical 10.14254/1800-5845.2015/11-2/2 analysis. The following results were produced in this investigation. The level of development of the local public sector is proportional to Keywords: the level of social satisfaction of the population and there are sig- Public goods nificant differences between territories in terms of the allocation of Social infrastructure infrastructural facilities. In addition it was shown that the population Territorial accessibility of the territory determines the financial capacity for the provision of Municipalities public goods and that the level of economic development influences Social satisfaction of the population the extent of the bureaucratic burden, the transparency of government and the level of public satisfaction with the work of executive authorities. The practical significance of the study lies in the possibility of using the results to develop recommendations to representatives of public authorities regarding the social infrastructural development of municipalities at the same time as increasing the social attractiveness of the territories.

1. INTRODUCTION The level of social infrastructural development of a territory is one of the features of its competitiveness; in particular, its social attractiveness. In general, infrastructure is understood in terms of the set of interrelated service structures or objects that consist in and provide the 31

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 basis for the functioning of the socio-economic system. In this connection, the social infrastructure, considered as the object of this study, is defined as the set of elements that create and provide the conditions for the spatial and temporal organisation of the lives of the population in the context of their needs and values as well as their social, demographic and other characteristics. It should be noted that, due to the significant distinguishing characteristics of the formation of the social infrastructure of rural areas and cities, the specified object of the authors' study was limited to municipal entities. Social infrastructure establishes the necessary conditions for supporting social needs and improves quality of life, creating conditions for stability, security, law and order, as well as supporting the development of sport, culture, health and educational services (Nesbitt and Ziller, 2001). The social infrastructure problematic is closely linked to research on quality of life and social well-being. Such studies, finding their basis in the writings of Nobel laureate D. Kahne- man (Rabin, 2003) and John D. Kahneman (Rabin, 2003), as well as those of J.K. Galbraith (Galbraith, 1973) and R. Layard (Layard , 2006), include the influence of the infrastructure on the formation of the qualitative characteristics of a territory's social environment. At the same time, any consideration of the social infrastructure should be addressed towards public, socially significant benefits, the research foundations of which were may be accessed in the works of Paul Samuelson (Samuelson, 1954), R. Musgrave (Musgrave, 1959), H. Margolis (Margolis, 1982), M. Olson (Olson, 1965) and others. When analysing the social infrastructure of cities, additional reference can be made to the academic literature that deals with problems of their internal structure and size as well as with the optimal placement of public service facilities and the classification of the branches of the city's social infrastructure (Hen- derson, 1977). Special attention should be paid to the regulatory issues concerning the provision of public goods. In this connection, the work of the French economist J. Tirole (2014), which provides a detailed consideration of the mechanisms used to stimulate the production of public goods, was recognised in his awarding of the 2014 Nobel Memorial Prize in Economic Sciences. One of the most important parameters that characterise a city's social infrastructure consists in its spatial (territorial) availability. The spatial (territorial) availability of social infrastructure is understood in terms of the rational distribution of social facilities, providing unimpeded public access to the available resources. However, due to the features of the development of a region (or a municipal formation) depending on many different factors, the question concerning the optimal allocation of public goods that contribute to the social attractiveness of a region and the level of development of its social infrastructure remains open. In order to make a more detailed study of this area of research, it is first necessary to examine how public goods are currently distributed in urban areas and how the manner of this distribution affects the level of social satisfaction of the population. Consequently, the aim of this study is to evaluate the spatial accessibility of public goods that form the social infrastructure of urban areas. Over the course of the present study, the authors considered the social infrastructures of individual territories within the Russian Federa- tion. In order to present a characterisation of trends in the social infrastructural development, literature dealing with the concept and structure of social infrastructure as well as its institutional features was reviewed and a number of hypotheses were formulated. Corroboration of the indicated hypotheses was carried out by means of an empirical study, whose results were analysed in conformance with a formulation of the general trends obtaining within the respective territory.

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 2. SOCIAL INFRASTRUCTURE One of the characteristics of the level of development of the social infrastructure is the efficiency of material resources used in order to improve the quality of life within a given territory; this also serves as an indicator of the level of its socio-economic development. Within the framework of the present study, a special focus is placed on an analysis of the municipal infrastructure; this is understood as the set of industries that serve to create and support the organisational, economic and social conditions in a particular area, taking into account specific features that support the normal functioning of the economy and the quality of life of the population. In the process of developing the social infrastructure of the municipalities, the participation of the following subjects is noted:  the State in the form of bodies for taking decisions and monitoring their implementation;  state-owned enterprises;  the general population;  private companies involved to varying degrees in the production process. Among the features of the development of the social infrastructure, it is necessary to note the following. Firstly, the direction of development and specificity of the social infrastructure is determined, above all, by the needs of individuals. In general, the list of requirements is fairly standard; however, the set of benefits and the means by which they may be satisfied varies depending both on the developmental level and on the cultural characteristics of a given territory. Secondly, due to the growing needs of the population typically associated with the economic development of a given territory, its social infrastructure tends to become gradually more complex over time. If household requirements are not being met by traditional institutions, individuals are forced to turn to market-based exchanges at which point they collide with the filters of price-based controls and the rent-seeking behaviour of agents in the respective markets. If the market mechanism is also unable to meet the needs of individuals, the State may intervene to meet these needs, guided by social preferences to overcome the filter of market availability (Fig. 1). A description of the relationships between the different types of institutions is schematically represented in Fig. 1.

Fig. 1. Institutional mechanisms for the satisfaction of needs

In this connection, the role of the State may differ from the institutional mechanisms for controlling interactions between agents (the legal environment) up to a full commitment to provide the necessary infrastructure. The choice of using one organisational mechanism or another for meeting the requirements is contingent on savings in transaction costs (Popov, 2014). With the aim of revealing the composition of the social infrastructure of a particular territory, various mechanisms denoting its differentiation have been taken into account. In particu- 33

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 lar, the social infrastructure was divided on the basis of its spatial characteristics into international, national, regional, etc. One of the most recent tendencies is to conditionally divide infrastructure into two parts according to the parameters of production and social facilities: "hard" and "soft." By "hard" infrastructure we refer to the significant physical networks (transport, roads, communication) that are necessary for the functioning of a modern industrial country. "Soft" infrastructure, on the other hand, consists of institutions that are needed to maintain the country's economic, health, cultural and social standards. Under the terms of "soft infrastructure" are also included such social systems such as finance, education, health, public administration and law enforcement agencies, as well as emergency services. In other words, the term "soft" infrastructure refers to all institutions that are necessary for the healthcare, cultural and social conditions of the country, the State and the company. With the exception of buildings and structures, all these elements are public goods. Thus, in our analysis of public (socially significant) benefits, we can use the existing classification system at the same time as taking into account their particular characteristics (Popov and Katz, 2014). Taking into account the practical competencies of the municipal authorities, the following infrastructure facilities were identified: − Local utilities, including electricity, gas, hot and cold water, heating, cleaning of the local environment; − Unified communal utilities, including the construction and repair of roads, landscaping, waste recycling, urban lighting; − Public transportation at the urban and regional levels; − Education and information, including kindergartens, schools, colleges and universities, post- graduate education, regional mass media, libraries; − Healthcare (hospitals, ambulances, clinics, etc.); − Recreation and culture facilities (parks, public gardens, children's playgrounds, sports clubs and playing fields, museums, theatres, zoos and the like).

The presented activities generally reflect the composition of the public goods provided by the social infrastructure at the level of the municipality. The impact of urbanisation on the development of municipalities has led to the formulation of hypotheses concerning the impact of the size of the settlement on the accessibility of a given infrastructure facility, the uniformity of distribution of social facilities according to the demands of the population, the size and the structure of the local sector, the distribution of public good sand the elasticity of demand for public goods.

3. METHODS The selection of primary research methods is determined by the specific character of studies aimed at assessing the degree of public satisfaction with the spatial accessibility of social benefits, i.e. an empirical survey of respondents combined with statistical analysis. Over the course of the study, the following hypotheses were formed: 1) The characteristics of the level of development of the local public sector is a more significant parameter in determining the level of social satisfaction than gross regional product (GRP), average income or the cost per square metre of residential real estate. 2) There are significant differences between territories in terms of the allocation of infrastructure:

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 a) the smaller the town, the higher the availability of territorial infrastructure; b) the smaller the town, the more evenly distributed the infrastructure, as well as the less satisfied the population with the volume and structure of the local public goods sector; c) the smaller the town, the less elastic the demand for local public goods. 3) The differences in the development of infrastructure across the different territories are due both to divergences in socio-demographic terms as well as to variation in financial capacity and bureaucratic arrangements: a) The larger the population of the territory, the more significant its financial capacity for the provision of public goods and the greater its financial independence; b) The more economically developed the territory, the lower the bureaucratic burden on the population and the higher the information transparency of the authorities; c) The more economically developed the area, the higher the satisfaction of the population with the organs of executive power; d) The more diverse the cultural, ethnic and age composition of the population, the lower the assessment of the executive authorities; e) The higher the dynamics of population growth, the higher the expenditure on social services. The authors used data provided by the Federal State Statistics Service as well as that obtained from the empirical study. The questionnaire prepared by the study was posted on the website at ianketa.ru and included 16 closed questions aimed at evaluating the relevance of infrastructure to the respondents, the disclosure of territorial availability of the test list of benefits (facilities for health, education, recreation and culture, security and policing, consumer services, transport, etc.), the level of social infrastructure development from the perspective of the population, an estimate of the elasticity of demand and social satisfaction as well as measurement of relevant socio- demographic characteristics. The evaluation of the infrastructure was carried out with the help of quality and availability indicators, subjectively measured by the respondent according to a 10-point scale. Territorial accessibility was measured by the time spent by the respondent to access the relevant infrastructure facility in regular use of the social good with additional evaluation being expressed in kilometres. In order to estimate the elasticity of demand, a question was asked concerning to what extent a change in the volume of a particular use of the infrastructure facility changes if the unit price of the benefit is varied by 10%. The evaluation of social satisfaction was performed by grading against a corresponding 10-point scale. A total of 1315 questionnaires were received, out of which, after rejections were taken into account, a response of 1143 adult residents of different cities of Russia remained. Of the 23 cities participating in the survey, 18% were small, 26% were average, 20% were large and 36% had over a million inhabitants (corresponding to the distribution of the 2010 census of 28%, 28%, 16%, 27%, respectively). The resulting sample is declared to be representative and the data to be reliable. The standard error of the sample does not exceed 5%. In confirmation of hypotheses 1 and 2, a correlation analysis of the data sets obtained during the interview was carried out as well as relevant statistical characteristics represented by the Federal State Statistics Service. Regarding the confirmation of the hypothesis, three databases were compiled from national statistics on the size of population of the territory, which showed gross regional product, the volume of tax revenues raised from the Russian Federal Subject and grants issued to thereto from the federal budget as well as the expenditure amounts of the consolidated budget of the

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 Russian Federal Subject in terms of the cost of the employees of state authorities and local self- government. The correlation analysis yielded the results detailed in the following section. In identifying patterns between the economic development of the territory and public satisfaction with the work of executive bodies, two indicators characterising the satisfaction of the population with the work of state bodies were considered: the population's evaluation of the executive bodies of the subjects of the Russian Federation (on a 100-point scale) and the satisfaction of the population with the activities of the executive authorities of the Russian Federa- tion (percentage of respondents). Both of these indicators were analysed with respect to their effect on the economic development of the region (GRP and GRP per capita). In order to assess the diversity of the population (hypothesis 3d), the ethnic composition of the Russian federal subject was analysed against ethnicity criteria. The proportion of ethnic Russians in the total population was chosen as a basic comparative indicator. The evaluation of the influence of diversity on the age demographic was conducted in relation to the birth rate relative to the number of retirees, with generational diversity defined as the proportion of births on the proportion of pensioners, as well as serving as an indicator of natural population growth. The composition of cultural diversity was assessed by attendance of theatres, museums and libraries as well as the proportion of people with higher education and the number of graduates of different levels of educational achievement against the proportion of those defined as living in poverty. Dependency indices were examined both in relation to the indices themselves and in relation to the weighted values, demonstrating the culture gap between the various population groups. The second part of the study aimed to provide a more detailed account of the spatial accessibility of infrastructure facilities, resulting in an analysis of the three regions of Russia consisting of Moscow, Sverdlovsk and Chelyabinsk. The aim of this in-depth analysis was to identify the weakest points in relation to security of the necessary infrastructure of the Russian Federa- tion, as well as determining the value of the dependency between the real needs of the population of the regions and the regulations established in each region1. The choice of the presented methods of investigation is due, on the one hand, to their simplicity, and, on the other, the ability to show trends in the development of the territory's social infrastructure. The difficulties encountered at this stage may be associated with an incomplete match of the characteristics of the sample population.

4. RESULTS From the study of territorial availability of public goods that form the social infrastructure of urban areas, the following results were obtained. As part of the verification of the hypothesis 1, a weak dependency was found between the level of security in relation to the social benefits of the gross regional product, considered as the main indicator of development in the region (r=0.06), the average salary, considered as the main indicator of well-being (r=0.15), and the cost of per sq.m. of residential real estate, is regarded as one of the characteristics of the level of infrastructure development (r=-0.25). This denotes a stable positive dependency between the level of provision of social benefits and the level of social satisfaction (r=0.56). Figure 2 shows the change in the mean levels of social satisfaction at different levels to ensure social benefits.

1 Moscow Region Urban Planning Regulations of January 16, 2012 № 24/54; Sverdlovsk Region Urban Planning Regulations of 15/03/2010, № 380-PP; Chelyabinsk Regional Planning Regula- tions (draft). (Norms of urban planning of Sverdlovsk region 03.15.2010, № 380-PP; Norms of urban planning of the Moscow region, 16. 01 2012 № 24/54; The regional urban planning regulations of the Chelyabinsk region (draft). URL: pravmin74.ru/sites/default/files/proekt_rgncho_-_skor._0. doc) 36

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 Fig. 2. Level of satisfaction with the level of the provision of social benefits

Consequently, hypothesis 1 was confirmed.

Regarding the verification of hypothesis 2a, concerning the influence of the size of the settlement of the territorial availability of social infrastructure, demonstrated that the closest corre- spondence to the criterion of territorial accessibility was for kindergartens, post offices and sports fields – the average distance of these facilities from consumers is 1.5-1.8 km. In this connection, the territorial accessibility (distance from consumer) for these facilities is characterised by medium-sized cities. The most significant differentiation was demonstrated in terms of accessibility to museums and universities – the distance varies from 1 to 13 km, with maximum values typical for megacities. The distribution of accessibility of cities by type is shown in Fig. 3. On average, the accessibility of these facilities reduces with an increase in the size of the city, confirming the hypothesis.

Fig. 3. Distribution of territorial accessibility (km) by type of urban infrastructure

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 When testing hypothesis 2b in the context of the sectional population of cities using standard deviation analysis, the first part of the hypothesis concerning the uniform distribution of the infrastructure was rejected. In this connection, in total, the overall set of infrastructural benefits observed the following trend: infrastructural facilities are distributed more uniformly over the entire area of cities with fewer than 1 million people, as well as in cities of over 5 million people. For the most part, the megacities show substantial heterogeneity in the distribution of facilities from the centre to the outskirts. A more detailed typological analysis of the benefits showed what, first and foremost, is typical of education facilities; whereas, in terms of health facilities, there is uniformity across all types of cities; in the case of parks, museums and libraries, the unevenness of distribution of facilities increases with the size of the city. With regard to public satisfaction with the scope and structure of local public goods sector, the analysis revealed a significant dependency of subjective estimates of the extent of the city's infrastructure development. Figure 4 shows how the size of the settlement affects the average estimate of the level of social infrastructural development.

Fig. 4. Dependence of the level of infrastructure development on the size of the locality

Thus, the second part of hypothesis 2b is confirmed. Regarding the testing of hypothesis 2c, the following results were obtained. The average consumption of infrastructure services with increase in price is reduced when the size of the city increases. Thus the average reduction in demand for small and medium-sized cities is 22-23%, whereas for megacities it is 26% (see Table. 1, with values showing the proportion of the consumption of services from the initial volume, taken as 1). The most substantial demand elasticity dependency relative to city size is observed in relation to museums and sports facilities, which shows a reduction in consumption of 30% -35% with an increase in price (the dependency coefficient was 0.47 and 0.41, respectively). Demand for medical services and transport is less elastic, with the average change of consumption volumes accounting for around 20%. In addition, there is a dependency of elasticity of demand on income, also the most significant for medical and transport services (r = 0.54 and r = 0.53, respectively).

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 Table 1. Average values of changes in demand for services with a price change of 10%

Postal Av. Med. Kindergartens H.E. Museums Sport Transp. Sers. value. Small 0.94 0.63 0.63 0.81 0.75 0.88 0.81 0.78 Average 0.81 0.86 1.00 0.76 0.56 0.73 0.67 0.77 Large 0.92 0.83 1.00 0.67 0.50 0.67 0.75 0.76 Megacities 0.77 0.78 0.76 0.69 0.65 0.69 0.80 0.74

Data source: “Town Planning Code of the Russian Federation” of 29/12/2004 N 190-FZ (rev. 31/12/2014) (rev. and ext. & in force from 04/01/2015)

Consequently, hypothesis 2c was confirmed. Regarding the testing of hypothesis 3, the following results were obtained. Correlation analysis of population and gross regional product (hypothesis 3a) demonstrated the close relationship of these indicators – the dependency coefficient was 0.91. The dependency between these parameters is exponential, as illustrated in Fig. 5a. Financial opportunities in relation to the development of infrastructure and social programmes are supported by tax revenues. The analysis of the dependence of the tax revenues of the RF subject on the size of its population showed a close relationship (r = 0.92). This dependency is similarly exponential (Fig. 5b).

Fig. 5. Dependency between size of population and GRP, volume of tax revenues

(a) (b)

The level of financial independence, measured by the volume of subsidies from the federal budget, also showed an association with the size of population; in this respect the dependency was inverse, i.e., with an increase in the size of the territory, its financial dependency is reduced. The dependency coefficient was -0.62. The logarithmic dependency is graphically represented in Fig. 6. 39

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 Fig. 6. Relationship between the population and the federal budget subsidy amount

Consequently, a region’s economic well being and financial capacity grow significantly with an increase in its size, whereas the dependence on the federal budget is considerably reduced. The hypothesis is confirmed. In testing hypothesis 3b, the metric of Gross Regional Product (GRP) was taken as the basic parameter of the economic development of the territory. Correlation analysis showed that the relationship between GRP and the number of municipal employees in the local government of the Russian Federal Subject per 10 thousand inhabitants is inverse and characterised as significant; the dependency coefficient was 0.76 (Fig. 7a). In this connection, in relation to the consolidated budget of the Russian Federal Subject in terms of the cost of the employees of state and local government authorities, a positive dependency is observed (r = 0.88). Although the rate of expenditure growth slows down with an increase GRP (Fig. 7b), in general, it can be noted that a nominal reduction in staff numbers is not accompanied by a corresponding reduction in the financial budgetary burden.

Fig. 7. Relationship between GRP and the indicators for the level of bureaucracy in the region

(a) (b) 40

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 However the indicator available in public satisfaction statistics concerning information transparency of executive authorities of the Russian Federation did not show such a close connection with GRP (r = -0.44). Curiously, this relationship is negative, i.e., with growth in economic development; the information openness of the authorities tends to be reduced, although this relationship is not particularly stable. When subjectively evaluated by respondents, information transparency demonstrated a positive dependency with the number of municipal employees in the local government of the Russian Federal Subjectper 10 thousand population (r = 0.63). Thus, the territories with the highest levels of bureaucracy tend to disclose information to improve their rating in the eyes of the population – all the more so, since information transparency significantly affects the assessment of public satisfaction with the activities of the executive authority (r = 0.64). Based on the results of the analysis, it should be noted that the hypothesis has not found clear confirmation under contemporary Russian conditions. In identifying patterns between the economic development of the territory and public satisfaction with the work of executive bodies (hypothesis 3c), two indicators were considered as characterising the satisfaction of the population with the work of state bodies: the population's evaluation of the executive bodies of the Russian Federal Subject (on a 100-point scale) and the satisfaction of the population with the activities of the executive authorities of the Russian Federation (percentage of respondents). Both of these indicators were analysed with respect to their effect on the economic development of the region (GRP and GRP per capita). The results demonstrated a strong dependency of these parameters with the index of GDP per capita (r=0.75 and r=0.55, respectively), while the connection with GRP was fairly weak. An illustration of the relationship between GDP per capita and the evaluation of government agencies is shown in Fig. 8.

Fig. 8. Relationship between GRP per capita and the evaluation of government agencies

Thus, the level of economic development of the area does have an impact on the satisfaction of the population; nevertheless, the population estimates the result to a greater extent in terms of the development of the region, not in comparison with other regions but in proportion to the increase attributable to each inhabitant of the region. The hypothesis is confirmed. It should be noted that, although the rating of government agencies is rising, in general, the satisfaction of the population with the work of state bodies remains fairly low. 41

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 In order to assess the diversity of the population (hypothesis 3d) the ethnic composition of the regions of Russia was analysed against ethnicity criteria. The proportion of ethnic Russians in the total population was chosen as a basic comparative indicator. Correlation analysis showed a significant dependence on this indicator in relation to the index of satisfaction with the activity of state bodies (r = 0.75). The dependence is shown graphically in Fig. 9a. Conse- quently, the hypothesis that the more diverse the ethnic composition of the territory, the lower the evaluation of state bodies is likely to be, is partially confirmed. The evaluation of the influence of diversity on the age composition was conducted in relation to the birth rate relative to the number of retirees, with generational diversity defined as the proportion of births relative to the proportion of pensioners, as well as serving as an indicator of natural population growth. Of these indicators, only the natural growth rate indicator demonstrated a close relationship; nevertheless, the impact turned out to be the most significant in relation to the indicator of the evaluation of the activities of State bodies (r = 0.72). Conse- quently, age diversity does not have a significant impact on these estimates; however, a positive dynamics of natural population growth leads to improved ratings of the activities of the executive authorities (Fig. 9b).

Fig. 9. Dependency of the performance indicators of the activity of state bodies of the national structure and the dynamics of natural population growth

(a) (b)

The composition of cultural diversity was assessed by comparing attendance at theatres, museums and libraries as well as the proportion of people with higher education and the number of graduates at various levels against the proportion of those defined as living in poverty. Correlation indices were examined both in relation to the indices themselves and in relation to the weighted values, demonstrating the culture gap between the various population groups. However, neither the principal nor the weighted values were demonstrated to have a significant impact on the ratings of government agencies. Thus, only ethnic diversity can be considered as a factor in determining evaluations of state agencies; the hypothesis was partially confirmed. As regards the testing of hypothesis 3e concerning the dependence of social spending on the dynamics of population growth, the following results were obtained. Since additional population growth creates additional demand for public goods, it is logical to assume a positive dynamics between these indicators, which could be sufficient to demonstrate the flexibility of the existing system infrastructure. In order to analyse the population

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 growth, two indicators were considered – the natural increase (due to the birth rate) and the growth of the population as a consequence of migration. Correlation analysis showed that while the correlation coefficient of natural increase and the share of social spending amounted to 0.71, the indicator of increase (decrease) of the population due to migration did not show a close connection (r=-0.25). Thus, there is a strong positive correlation between the rate of natural increase per 1,000 population and the proportion of the total expenditures of the consolidated budget of the Russian Federal Subject that are allocated to social services (Fig. 10); the hypothesis is partially confirmed.

Fig. 10. Relationship between the natural increase of the population and the proportion of social spending

Table 2 presents the results obtained from the second part of the study, which included an analysis of the availability of infrastructure facilities across three regions of Russia – Moscow, Sverdlovsk and Chelyabinsk.

Table 2. Territorial accessibility of infrastructure facilities in the Moscow region

Facility Standard, km Actual pedestrian access, km Deviation, times Kindergartens 0.65 1.68 2.58 Schools 1.25 1.68 1.34 H.E. Not specified 13.47 Outpatient clinics 1.25 2.30 1.84 Library 0.65 2.47 3.80 Museums 0.65 10.30 15.85 Parks 0.65 4.62 7.11 Playing fields 0.65 2.94 4.52 Post offices 0.65 1.09 1.68

Data source: Moscow Region Urban Planning Regulations of January 16, 2012 № 24/54

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 The data in Table 2 show that the availability of infrastructure lags far behind the standard indicators. Pedestrian access to clinics is two times below the regulatory level; preschools – 3 times lower; libraries and sports grounds – 4 times lower; parks – 7 times lower; and museums – 15 times lower. Only for schools and post offices are the actual figures close to the accessibility regulations. As regards the Sverdlovsk region, health clinics are the facilities for which access is closest to the regulatory norm. Pedestrian access to libraries is two times below the regulatory level; preschools – 3 times lower; schools and pre-school facilities – 4-5 times lower; museums and parks – 6-7 times lower; and universities – more than 10 times lower. (Table 3)

Table 3. Territorial accessibility of infrastructure facilities in the Sverdlovsk region

Facility Standard, km Actual pedestrian access, km Deviation, times Kindergartens 0.4 2.16 5.4 Schools 0.6 2.81 4.7 H.E. 0.7 10.99 15.7 Outpatient clinics 1.0 1.60 1.6 Library 1.1 2.62 2.4 Museums 1.3 7.69 5.9 Parks 1.1 3.50 3.2 Playing fields 0,5 2.70 5.4 Post offices 0.6 1.12 1.9

Data source: Sverdlovsk Region Urban Planning Regulations of 15/03/2010, № 380-PP.

The Chelyabinsk region is characterised by a close compliance between stated norms and the actual availability of infrastructural facilities: thus, access to libraries, sports facilities and post offices is close to the normative values in terms of proximity to the consumer; real values representing access to parks and clinics even exceed those stated in regulations. The results of the analysis of the Chelyabinsk region are presented in Table 4.

Table 4. Territorial accessibility of infrastructure facilities in the Chelyabinsk region

Facility Standard, km Actual pedestrian access, km Deviation, times Kindergartens 0.4 1.2 3 Schools Not specified 1.7 H.E. Not specified 4.13 Outpatient clinics 1 0.77 0.77 Library 1.1 1.27 1.15 Museums 1.1 1.8 1.64 Parks 2.4375 1.03 0.42 Sports playing fields 1 1.23 1.23 Post offices 0,5 0.7 1.4

Data source: Urban Planning Regulations of the Chelyabinsk Region (draft). 44

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 As can be seen from the presented analysis, distinctions are provided not only by indicators of actual access to the infrastructural facilities of the study area but also by those relative to norms established in those areas. Differences in regulatory parameters are a natural reflection of the differentiated approaches taken by the regional authorities towards defining the needs of the population and evaluating the possibilities of satisfying those needs.

5. DISCUSSION The findings of the empirical research and the results of the statistical analysis revealed patterns of spatial accessibility to public benefits that characterise the social infrastructure of urban areas. The results showed that the level of development of the social infrastructure is highly significant in terms of the overall socio-economic development of the territory. Thus in urban con- texts a significant cross-sectional heterogeneity is observed in terms of the quality and availability of infrastructural facilities: significantly more extensive development in relation to the quality of urban growth but at the same time an increase in the heterogeneity of distribution facilities, which greatly reduces their accessibility to the population. The confirmation of hypothesis 1 concerning the significance of the level of development of the local public sector in relation to social satisfaction in comparison with indicators such as gross regional product, average earnings and the cost per square metre of residential property shows that the level of individual satisfaction grows with the direct satisfaction of their needs, which is ensured not just by the "capacity" to meet social needs but by the actual availability of adequate social infrastructure and spatial accessibility. However, the level of social infrastructure development is often dependent on the level of economic development of the territory as a whole. However, in this case, the data analysis set out to show the dependency of the level of satisfaction of the population on the GRP and average salary, which was not revealed. This is due to the existence of a certain lag between the period of economic growth and the ability of the social infrastructure to meet the needs of society. The confirmation of hypothesis 2a, concerning the inverse influence of the size of the settlement on accessibility to social infrastructure facilities across the territory, indicates that the capacity of local authorities to provide the required volume of social benefits lags behind the needs of the population. In general, this is due to the high dynamics of development of various spheres of economic activity and the uneven development between different areas of large cities – as well as to the presence of a time lag between changes in the size and needs of the population and the actual manifestation of these requirements in the form of the required number of facilities. In addition to having a more stable population, smaller cities also have a greater potential for operational management of the given sphere due to the smaller number of facilities needing to be accounted for. Taken together with the results obtained in the course of testing hypothesis 2b concerning the greater uniformity of distribution of infrastructure and the differences in the quality of services with an increase in the size of the city, the results obtained during the testing of the hypothesis pattern 2a show that the quality of infrastructural facilities is more decisive with regard to the social satisfaction of the population than their territorial accessibility. The confirmation of hypothesis 2c (the smaller the town, the less elastic the demand for local public goods) is due to the limited diversity of the supply of social infrastructure in small towns. It is natural that with an increase in the size of a city the possibilities to refer to other sources, including commercial, to satisfy relevant needs, also increases: this determines a higher elasticity of demand. At the same time, in relation to universities, hospitals and trans-

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 port, this regularity is absent. Apparently, this is due to the higher specificity of these social facilities and consequently fewer opportunities for the replacement of one facility by another. Such considerable differences between small and large cities can be explained as follows. In the first instance, the larger the quantity, the greater the financial opportunities for infrastructure development. Major population centres are centres of attraction both for people and financial flows, resulting in a higher flow of tax revenues and greater financial independence. Active economic development also stimulates the activity of the executive power, which has a positive effect on the quality and availability of infrastructure; this is in turn reflected in higher public satisfaction ratings. However, there is a noticeable decline in public satisfaction in the multinational regions due to significant differences between the different nationalities in terms of their needs and the means used to satisfy them. At the same time it is characteristic of Russia that age-related, economic and cultural differences do not exert significant effects. It should also be noted that the territories showing high positive dynamics of natural population growth also demonstrate positive dynamics in terms of pace of development of appropriate infrastructure, which positively characterises the flexibility of local governments. The results obtained in the second part of the study characterise the overall state of the various types of social benefits existing in the study area. It is possible to draw certain conclusions from the ratio of regulatory and actual values that characterise the spatial distribution and availability of public goods and to base recommendations concerning the optimisation of this process on these conclusions. For example, an analysis of the social infrastructure of the Moscow region showed that the authorities should pay special attention to the spatial distribution of museums, parks and sports grounds. Concerning the issue of spatial accessibility in the Sverdlovsk region, it is necessary to focus attention on the distribution of kindergartens, schools, museums and sports grounds. In the Chelyabinsk region, actual accessibility is slightly higher than normative, testify- ing to the high social attractiveness of the area. In general it should be noted that the identified patterns characterise Russia as comprising a wide variety of economic, geographic and cultural characteristics. The population highly values the importance, availability and quality of the social infrastructure. At the same time, when considering the uneven development of certain sectors, the most important areas from the standpoint of the population include recreation, sports and culture. There are significant size- related differences: in large cities, there is a much more developed infrastructure, which consti- tutes the centre of attraction of migratory flows. However, it naturally occurs that the territorial availability of infrastructure is reduced with the size of the city and there is inequality in the distribution of objects from the centre to the outskirts. This is particularly evident in relation to parks, museums, libraries and universities; to a lesser extent, this also applies to kindergartens, post offices and sports grounds. Furthermore, with an increase in the size of the city, infrastructural elasticity of demand will also increase due to the wide variety of infrastructural facilities. The comparative analysis allows us to identify the primary needs of the region in terms of improving the quality of services in the social, cultural and general spheres – as well as in the terms of the provision of recreational facilities. In general, the given data in the three regions show insufficient provision of basic facilities (kindergartens, secondary schools, health care facilities, recreational areas and sports facilities), allowing us to identify the main socio-economic problems of the regions and to propose recommended directions for their development.

6. CONCLUSION In order to analyse the spatial accessibility of public goods that form the social infrastructure of urban areas, the present study identifies the influence of various factors on the level of social satisfaction of the population, leading to the following conclusions.

Evgeny V. Popov, Irina S. Katz, Anna Y. Veretennikova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 31-48 Firstly, the level of development of the local public sector is proportional to the level of social satisfaction of the population. Secondly, there are significant differences between territories in terms of the allocation of infrastructural facilities. Through the course of the study it was revealed that the size of the settlement (in terms of population) is inversely proportional to the availability of social infrastructural facilities; that the populations of smaller towns place less demand on the volume and structure of the local public goods sector than the populations of larger towns; and that elasticity of demand for local public goods depends on the size of the locality. Thirdly, in terms of the characteristics of the development of infrastructure in the territories, distinguished both by differences in socio-demographic indicators and by differences in financial resources and bureaucratic mechanisms, it was shown that the population of the territory determines the financial capacity for the provision of public goods and that the level of economic development influences the extent of the bureaucratic burden, the transparency of government and the level of public satisfaction with the work of executive authorities. The practical significance of the study lies in the possibility of using the results to develop recommendations to representatives of public authorities regarding the social infrastructural development of municipalities at the same time as increasing the social attractiveness of the territories in question. In terms of the further development of the identified issues, it is anticipated that the features of a sustainable institutional framework of public goods will be defined alongside the development of a methodology for assessing the cost-effectiveness of the optimal structure of public goods.

Acknowledgements This study received support from the Russian Foundation for Basic Research, project N 14- 06-00024. The authors would also like to express their gratitude to the editor in chief and to the anonymous reviewers for the peer review.

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Frank Iyekoretin Ogbeide, Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64

Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 49-64 ‘

The Determinants of Unemployment and the Question of Inclusive Growth in Nigeria: Do Resource Dependence, Government Expenditure and Financial Development Matter?

Frank Iyekoretin Ogbeide 1, Hillary Kanwanye 2, Sunday Kadiri 3

1 Department of Economics and Statistics University of Benin, Benin City, Nigeria; [email protected] 2 Department of Economics and Statistics University of Benin, Benin City, Nigeria; [email protected] 3 Department of Economics and Statistics University of Benin, Benin City, Nigeria; [email protected]

ARTICLE INFO ABSTRACT Received June 11, 2015 Abstract The paper examines the determinants of unemployment in Received in revised from Sept. 2015 Nigeria from 1981 to 2013, using error correction model (ECM), and Accepted November 19, 2015 with ordinary least squares method for robustness check. The study Available online Decembre 3, 2015 finds that output size (measured by GDP), foreign direct investment, exchange rate depreciation, and trade openness curb labour unem- JEL classification: ployment in Nigeria, while factors that worsen labour unemployment include financial development (measured by private credit), intensive J21, J24, J64 capacity utilisation, and natural resource rent. Government capital

expenditure, though not significant, increases unemployment rate in DOI: Nigeria, alluding to corruption and the tendency for public officers to 10.14254/1800-5845.2015/11-2/3 divert funds to accumulate political capital, rather than socially productive ones. Inflation produces mixed outcome in both the short-run and Keywords: long-run estimation. The study has confirmed that resource depend- Capacity Utilization, ency, shallow financial depth, poor public expenditure management, Natural Resource Curse, and wrong production technology choice undermines unemployment in Institutional Quality & Unemployment. Nigeria, and thus attainment of inclusive growth. This calls for intensified efforts at financial sector liberalization drive to broaden the financial system, improve institutional quality, and adopting economic diversification strategy to reduce structural misalignments and attain a non- declining inclusive growth in Nigeria.

1. INTRODUCTION The statistic on unemployment rate is one of the most prominent indicators of how well an economy is performing because of the perceived difficulty to finding a job, especially during periods of recession. Thus, knowledge of factors that influences unemployment rate could be a veritable platform to designing and adopting appropriate policy strategy aimed at achieving inclusive growth. Although unemployment applies to all resource inputs used in production process, the term is however, used in relation to labour unemployment in both political and eco-

Frank Iyekoretin Ogbeide , Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 nomic circles (see Iyoha, et al., 2003). The reason is that the bizarre movements in labour employment also translate directly to employment outcomes of other factor inputs. In Nigeria, for example, of the vast increases in population growth annually, it has been observed that unemployment rate has continually maintained an upward trajectory, especially since year 2001. It averaged 14.7% and 18.5% for 2001 - 2010 and 2011 - 2013 periods, respectively, from an average of less than 6% in 1981 to 2000 periods. Most economic indicators for the period rose relatively, including capacity utilization rate, real GDP, FDI and government expenditure. The broad trends are summarized in Table 1.

Table 1. Selected economic indicators, 1981 – 2013

Indicators 1981-1990 1991-2000 2001-2010 2011-2013 Unemployment Rate 5.36 5.54 14.70 18.57 Real GDP per Capita 598.25 550.33 793.11 942.30 Natural Resource Rent 37.20 39.05 34.64 33.95 Govt Capital Expenditure (N'billion) 8.98 184.37 618.17 869.91 Private Credit/GDP 9.84 8.17 17.32 20.94 Aggregate Firms’ Capacity Utilisation Rate 47.36 34.30 53.65 54.91 Foreign Direct Investment/GDP 1.99 4.62 3.30 2.85 Inflation 19.91 30.58 13.43 11.04 Secondary School Enrolment Rate 25.08 24.46 33.88 38.78 Population (millions) 85.30 110.07 142.02 156.16

Sources: Author, but underlying data from IMF

Most economic researchers consider unemployment phenomenon as one of the greatest challenges facing the Nigerian economy and the quest to attaining inclusive growth. The rise in unemployment rate may be attributed to inappropriate policies adopted, especially the abandoning of the agriculture, which was before the oil-boom era, considered as the engine for economic growth. There are however, very limited studies which try to ascertain the determinants of unemployment in Nigeria from a broader perspective. A major contribution of this study is an attempt to endogenise unemployment by including both social and institutional factors to capture the structure and dynamics of the Nigerian economy. The reason is that it remains unclear what constitute the key determinants of unemployment in Nigeria. Does structure of economic arrangements matter? What role does the dependence on natural resources play in the current unemployment challenges in the country? Dependence on natural resource, for example, has been found to undermine institutional efficiency which also affects economic structure and growth trajectory (Beck, 2011). Has financial development, following financial reform in the past three decades in Nigeria, stimulated employment? Thus, financial development, through its interface with the real economy, then enters as a possible determinant of unemployment, and the variable has been overlooked in extant studies. This paper is organized into five sections. Following this introductory section, section two provides a review of relevant literature. Section three discusses theoretical framework, with methodology and model specification. Section four discusses the empirical results, while the last section contains concluding remarks, and recommendations.

Frank Iyekoretin Ogbeide, Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 2. REVIEW OF RELATED LITERATURE

2.1 Stylised Facts on Unemployment Incidence in Nigeria Structural factors and macroeconomic policies raise the spate of unemployment in Nigeria, especially among the young and jobless poor (see Garba and Garba, 2013). This may be attributed to the skewed nature of Nigeria’s fiscal system that is notably built around revenues from export of her hydrocarbon endowment. Several researchers have hinted that before the oil boom of the 1970s, agriculture was the mainstay of the Nigerian economy, accounting for a third of the gross domestic product (GDP); about two-thirds of labour employment, substantial supply of raw materials for industries, and large proportion of non-oil export earnings (see Iyoha, 1992; Canagarajah 1997; Obadan 1998; Auty, 2001). It seems logical, therefore, to expect that the poor linkage-effect of mining sector due to its enclave and capital-intensive nature would aggravate unemployment rate. Studies by Gelb, (1988); Auty, (2003) argued that inappropriate macroeconomic policies adopted during the resource-boom era, led to a massive misallocation of resources in Nigeria. A look at Figure 1 portrays a disturbing inverse relationship between unemployment rate and natural resource rent.

Figure 1. Trend Analysis of Credit to Private Sector and Natural resource rent, 1980-2013

Sources: Author, but underlying data from IMF

As documented in studies by Levine, (2005) the motivation of financial sector reform in most African countries was summarized into three categories, namely: the need to improve the monetary control system so as to boost the savings mobilization and allocation; to improve the banking system; and also to enhance the structure of interest rates. Broadly, financial liberalization was adopted in Nigeria with a view to boost financial depth, promote credit flow to the real economy, and hence stimulate employment and entrepreneurship. Access to financial services (savings and loans) is increasingly recognized as the link between growth and poverty reduction (Sowa, 2002; Arestis and Caner, 2004; Bakwena and Bodman, 2010; Zhuang, et al., 2009; IMF, 2013). Theory suggests that financial market imperfection is particularly harmful for poor entrepreneurs without collateral, credit histories, or connections. (Galor and Zeira, 1993; Gulde, et al., 2006). Empirical evidence indicates that finance is a binding constraint to firm growth (and by extension factor employment), and also among new firms that rely on external financing (see Beck, Demirguc-Kunt and Maksimovic, 2005).

Frank Iyekoretin Ogbeide , Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 Okojie (2013) hinted that with a population growth of about 2.7% – 3.2%` in Nigeria, and increases in labour force that far outstripped growth in number of available jobs would naturally result in high and unsustainable unemployment rate. National Population Commission, NPC’s 2010 Report indicates that 62% of the Nigerian population is below age of 25, while about 83% are under age of 40. Table 2 shows the growth rate of labour force, employment and unemployment from 2007 to 2011. It is often argued that idle persons can readily be culled and used like instruments by conflict-ridden member of the society for personal gain. The social dimension of high unemployment rate has proved daunting, and as such, many more researches have investigated the link between unemployment and economic growth (see Obadan and Odusola, 2001; Zagler, 2006).

Table 2. Growth rate of labour force, employment and unemployment in Nigeria

Year Labour Force Employment Unemployment Job Gains/ Job Loss 2007 3.20 2.73 6.56 1,375,259.00 2008 3.20 0.60 21.08 310,228.00 2009 3.20 -2.62 36.45 -1,364,820.00 2010 3.20 1.02 12.11 514,798.00 2011 3.20 -0.08 15.26 -42,231.00 Average 3.20 0.33 18.29 158.65

Source: Garba and Garba (2013)

A critical appraisal of Nigeria’s unemployment incidence can aptly be categorized in line with the unique demographic characteristics of the country. Table 3 shows the unemployment rate by age composition. From the table, it can be seen that the second highest cadre of unemployed persons in the country is among the so-called active-segment of the population, 25 to 44. However, in terms of the geopolitical structure of the country (Table 4), unemployment is highest in the North-East and North-West region of the country. This may cautiously explain the occurrence of wide-spread poverty, violence and insecurity in those parts of the country relative to other geopolitical regions. From the observed data and practices in Nigeria, the problems and causes of unemployment in Nigeria are multifaceted, and hence conventional theoretical expla- nations of unemployment become inadequate.

Table 3. Unemployment rate by age structure

Age Group Urban Rural Composite 15-24 33.5 38.2 37.7 25-44 16.3 24.1 22.4 45-59 12.5 19.6 18 60-64 17.8 22.1 21.4 National 17.1 25.6 23.9

Source: National Bureau of Statistics (2010)

Frank Iyekoretin Ogbeide, Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 Table 4: Geopolitical structure of Nigeria’s labour unemployment rate

Geopolitical Zone States Range % Benue(28.4%), Kaduna(25.7%), Kogi(20.1%), Nasarawa(21.6%), North Central 14.4 -28.4 Niger(19.4%), Plateau(14.4%), FCT(15.2%). Adamawa(23%), Bauchi(29.7%), Borno(26.5%), Gombe(29.2%), North East 23.0 – 39.0 Taraba(21.6%), Yobe(39%) Jigawa(28.6%), Kano(25.7%), Katsina(27.8%), Kebbi(17.6%), North West 17.6 – 33.4 Sokoto(32.4%), Zamfara(33.4%) Abia(21.6%), Anambra(21.3%), Ebonyi(20.3%), Imo(29.9%), South East 15.0 – 29.9 Enugu(15%) Bayelsa(20.7%), Cross River(20.4%), Edo(17.1%), Delta(27.2%), South-South 17.1 – 27.2 Akwa Ibom(25.8%) Ekiti(14%), Ogun(9.9%), Ondo(14.1%), Oyo(8.8%),Osun(17.2%), South West 7.6 – 17.2 Lagos(7.6%)

Source: Garba and Garba (2013)

2.2 Theoretical Literature There is an overwhelming consensus that to attain higher economic prosperity in any nation, the need to curtail unemployment is important. ILO (1989) defines the unemployed as "...persons who are available and looking for paid-employment, who have registered at any of the employment centres. This excludes persons seeking only temporary or part-time work; stu- dents seeking vacation work; persons with any employment seeking other work; retired or other pensioners and invalidity benefit recipients; persons on temporary or indefinite lay-off without pay; persons responsible for the loss of their last job; and persons on strike. However, the conceptual ILO definition of unemployment is increasingly seen as inadequate to characterize low income countries’ labor markets (see Cling, et. al. 2006; Fares et al. 2006; World Bank 2006). As noted earlier, there exist a plethora of factors that can cause unemployment. Econo- mists continue to differ on causes of unemployment and this fact can be seen in the theories of unemployment by foremost economists namely the Classical and Keynesian theorists, even among their disciples. The Classical economists assume that the labour market depends on the real wage that is perfectly flexible, adjusting quickly to equate demand and supply of labour. They posit that involuntary unemployment is a short-term phenomenon that arises from dis- crepancies between the general price level and money wage. Furthermore, they held that when labour supply exceeds demand, wage level must fall to restore equilibrium, though frictional and structural unemployment still exist. To this ends, output and employment are completely supply- determined such that aggregate demand plays no systematic role in explaining output. Keynes, on the other hand, believes that unemployment occurs when aggregate demand is relatively low, thus leading to demand-deficient unemployment or cyclical unemployment. The idea is that a fall in aggregate demand for goods would mean lower production since wage is assumed to be downward-sticky in the Keynesian system, thus leading to cut in jobs. Keynes believes that fiscal and monetary policies can be used to stimulate aggregate demand to curtail unemployment during period of economic recession. The short-run Phillip’s curve is another theoretical model used to explaining the existence of a relationship between inflation and unemployment created by fluctuations in aggregate demand. Although, recent empirical findings have found that the relationship between inflation and unemployment may be vertical in the long-run, rather than slope from left to right over the short-run periods. Okun’s law explains the causal relationship between unemployment and GDP. The implication of the theory leads to the conclusion that growth in GDP directly cut un- 53

Frank Iyekoretin Ogbeide , Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 employment rate. A study by Sogner and Stiassny (2002) in modifying the Okun’s law, pointed out that it is changes in aggregate demand in the economy that indirectly affect firms decision to expand or contract output, thus influencing labour demand, and hence unemployment. Meanwhile, the International Labour Organization (ILO, 1995) listed the phenomenon of ‘jobless growth’, macroeconomic instability, dysfunctional labour market, institutional weakness, political instability and lack of international competiveness as causes of unemployment crisis in developing countries. Financial development, induced by policies of financial reform policy, affects savings and investment decisions. Researchers like, Schumpeter, (1911); McKinnon, (1973); Shaw, (1973); Greenwood and Jovanovic, (1990); Bencivenga and Smith, (1991); King and Levine, (1993a); De Gregorio and Guidotti, (1995); Greenwood and Smith, (1997) contend that well-functioning financial system can promote overall economic efficiency because it can mobilize higher level of savings, enhance capital accumulation, transfer resources from traditional (non-growth) sectors to modern growth-inducing ones, and also promote a competent entrepreneur response to business opportunities. Increases in credit to the private sector should lead to a fall in unemployment due to business expansion.

2.3 Empirical Literature Studies have shown that the quality of institutions is instrumental in achieving both short- and long-run economic performance, with the possibility of enhancing income and employment opportunities (see North, 1990; Acemoglu, Johnson and Robinson, 2004; Pereira and Teles, 2010). The belief is that raising the level of economic activities even within the context of existing structure would invariably lead to increases in demand for factors of production, including labour, and more especially for labour-intensive production. Studies by Collier and Hoeffler, (1998); Leite and Weidmann (2002); and more recently by Ogbeide and Mustapha (2013) find that the presence of large deposits of natural resources, irrespective of the types - whether point resource (ores, fuel) or diffuse resource (agriculture), attracts rent-seekers with an overarching negative consequence on the development of appropriate institutions for sustainable long-term economic growth. To this ends, natural resource abundance and dependence, becomes a key structural and institutional factor that influences employment and economic performance dynamics. Empirical evidences indicate that resource- rich countries, on average, have lower and unsteady growth rates, compared to resource-poor countries (Mehrara, Musai and Karsalari, 2011; Sachs and Warner, 1997; Kurronen, 2012). Several studies have attempted to explain the causes of labour unemployment using broad- based macroeconomic indicators in diverse global regions of the world. Mortensen, (1970) sup- ports the existence of a trade-off between the money wage and unemployment rate which con- firms the Phillips curve analysis. Eita and Ashipala, (2010) examined the determinants of unemployment in Namibia from 1971-2007, applying the Engle-Granger two-step econometric approach. The finding of the study was in congruous with the Okun’s law and the Harrod-Domar model. Bakare, (2011) identified labour demand and supply of labour, population, inflation, capacity utilization, gross capital formation (GCF), wage rate and private domestic investment as major determinants of urban unemployment in Nigeria from 1978-2008. In line, Maqbool, et al. (2013) study revealed also that GDP, population, inflation and foreign direct investment are significant determinants of unemployment in Pakistan in both the short-run and long-run analysis for periods from 1976-2012. Bigsten, et al. (2000) and Miller and Upadhyay, (2000) found export-oriented economies to positively influence the growth level of productivity. On the other hand. Some literatures recognize the relationship between education and the incidence and duration of unemployment. Farber, (2004) finds that job losers with higher levels of education have

Frank Iyekoretin Ogbeide, Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 higher post-displacement employment rates and are more likely to be re-employed. Using UK data, Nickell, (1979) analyzes the relationship between education and the incidence and duration of unemployment. The study finds schooling up to 12 years reduces the duration of unemployment by over 4%, while education at ordinary levels and above reduces duration by 12%. Similarly, Mincer (1991); Adebayo, (1999); Echebiri, (2005); Okojie (2011) identified low standard of education and the rapid expansion of the educational system as some of the main causes of youth unemployment in Nigeria. The theoretical link between financial reform and employment opportunities is well- established due to its effects on real economic outcomes (See Epstein and Heintz 2006). In particular, Guiso, Sapienza, and Zingales, (2002) using dataset on households and financial services in Italy finds that financial development enhances the probability that an individual starts a business. Others studies like Sowa (2002); Arestis and Caner (2004); Bakwena and Bodman (2008, 2010); Zhuang, et al., (2009); and IMF (2013) observed that within the general context of macroeconomic reforms, financial development can lead to poverty reduction and employment if financial system makes credit available to the poor. The effect of government fiscal activities on economic growth, and by extension employment, may be ambiguous. Some studies observed that government intervention can crowd-in private investment, thus alluding to the complete interventionist role by government (Stigler, 1971; Cardoso, 1993; and Ramirez, 2000; Holden and Sparrman, 2014). Some others, for example, Lugo (2001) found contrary results, and sums that, government expenditure crowds-out private investment when: (i) government invests in inefficient state-owned firms; (ii) private investors expect higher taxes to finance increases in expenditures; and/or (iii) the public sector competes with the private sector for domestic credit. Other studies with similar negative effects of government interventions include Acemoglu and Verdier, (1998); Nwosa (2014). More so, studies have shown that inward foreign direct investment (FDI) influences unemployment rate through spill-over effects from economic growth. Researchers, like Brecher (2007), show that countries with huge influx of foreign investments will often witness remarkable output expansion which raises domestic labour demand.

3. THEORETICAL FRAMEWORK AND MODEL SPECIFICATION

3.1 Theoretical Framework This study adopts the Keynesian framework of aggregate demand. It is believed that aggregate demand is influenced by a host of decisions taken by both public and private sector. The public decisions are most evident in the monetary and fiscal policies. To the Keynesian theory, changes in aggregate demand, whether anticipated or unanticipated, greatly influence output and employment. Thus, stimulating the levels of aggregate demand becomes cogent theoretical link to improve employment and income. From the Keynesian theory, since equilibrium output/employment is given by the equality of aggregate demand and supply, it is expected that any factor that distort the aggregate demand and supply dynamics will invariably affect the employment status of factors of production. Thus, factors like nominal wage rate, price level and its expectation, aggregate consumption and investment level, government spending, as well as degree of economic openness. These variables may influence the equilibrium employment level through their varied effects on aggregate demand and supply dynamics. Inflation for instance, causes a fall in real money supply (M/P). It affects negatively business decisions to invest, and consequently, reduce aggregate demand, output and employment, ceteris paribus. Though, inflation can also serve as an inducement to investors to increase their production.

Frank Iyekoretin Ogbeide , Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 3.2 Model Specification This study follows Okun (1983) procedure to show how changes in unemployment is related to growth in real output. Hence, the model to evaluate the determinants of unemployment in Nigeria is tested in an error-correction modeling (ECM).

K LUNEMPt  0  1LGDPct  2 X t   ECM  t t 1 (1) LUNEMP LRPGDPx Where: t and t represent the dependent (unemployment rate) and real per capital GDP (explanatory variable), respectively, in their first difference; X represent other determinants of unemployment from extant literature.

∆LUNt = β0 + β1∆LCPSt + β2∆LNRRt + β3∆LGDPct + β4∆LTRDt +β5∆LCPIt + β6∆LEXR +

β7∆LGCEt + β8∆LCURt+β9∆LFDIt   ECM  + Ut (2)

Where: UN = Unemployment rate; GDP = gross domestic product; CPI = consumer price index; CUR = manufacturing capacity utilization rate; EXR = real exchange rate; TRD = trade openness; CPS = credit to the private sector; GCE = government capital expenditure; and NRR = Natural resource rent; FDI = Foreign direct investment. The symbol L shows that the variables are in their log form, while the operator ∆ represents first difference. While we use the error-correction modeling (ECM) approach to ascertain the speed of adjustment to long-run equilibrium from a possible short-run distortion, ordinary least square (OLS) was also estimated to ascertain the long-run function. The aim is to compare both results to further enhance policy formation and implementation process in Nigeria. The study avoid spurious regression by conducting preliminary test for stationarity using the Augmented Dickey Fuller (ADF), while Johansen Cointegration technique was employed to investigate the existence of a long-run relationship amongst economic variables. According to Asteriou and Hall, (2007), if the variables are cointegrated, they move together over time so that any disturbances in the short-run are corrected. This indicates that if two or more variables are co-integrated in the long- term, they may drift at random from each other in the short run, but will return simultaneously to equilibrium in the long run. Time-series data extracted from Nigeria’s National Bureau of Sta- tistics (NBS) and Central Bank of Nigeria (CBN), as well as from the International Monetary Fund (IMF) and World Bank’s World Development Indicators. This study employed the ratio of private credit/GDP1 as proxy for financial development. Other socio-economic factors considered in this study as control, are in line with findings from extant literature.

4 EMPIRICAL RESULTS OF REGRESSION ESTIMATION

4.1 Unit Root and Cointegration Test Prior to our empirical analysis, we tested for stationarity in the data for estimations. This is necessary to ensure consistent and efficient results. Our Augmented Dickey Fuller (ADF) test statistics are provided in Table 4, and all the variables are stationary at first difference. Thus, our examination concludes that all the series under study are integrated of order 1, I(1). Having confirmed stationarity in our series, it was also necessary to identify the cointegrating relation-

1 Private credit-to-GDP is often preferred to other measures of financial development in empirical literature because it shows the extent to which the private sector in an economy relies on financial system for funds, as it excludes credit given to the public sector. See studies by Beck, Levine and Loayza (2000); Tressel and Detragiache (2008). 56

Frank Iyekoretin Ogbeide, Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 ship before specifying our error correction model. Johansen (1988) procedure was adopted to ascertain whether the series are cointegrated. The cointegrated results are summarized in Ta- ble 5. From the result, the trace statistics revealed existence of at most six long-run equilibrium equations in the model. The test was conducted based on the 5% critical level and we do not reject the null hypothesis which states that there is no cointegration.

Table 5. Unit Root (Non-Stationarity) Test

ADF ADF Critical Order of Variables Remarks t-Statistics Values Integration *Capacity Utilisation -3.2 -2.96 I(1) Stationary Secondary School Enrolment -4.99 -3.56 I(1) Stationary Natural Resource Rent -5.75 -3.56 I(1) Stationary **Real GDP per capital -3.36 -3.21 I(1) Stationary Trade Openness -4.02 -3.56 I(1) Stationary Unemployment rate -6.95 -3.56 I(1) Stationary Inflation rate -5.33 -3.56 I(1) Stationary Government Capital Expenditure -6.76 -3.56 I(1) Stationary Private Credit -5.6 -3.56 I(1) Stationary

Notes: * shows stationarity without trend; ** show stationarity at 10% critical level

Table 6: Johansen’s Cointegration Test

Unrestricted Cointegration Rank Test (Trace) Hypothesized Trace 0.05 No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 0.970393 390.5759 228.2979 0.0001 At most 1 * 0.884766 281.4636 187.4701 0

At most 2 * 0.856132 214.4791 150.5585 0 At most 3 * 0.780206 154.3744 117.7082 0 At most 4 * 0.740209 107.4074 88.8038 0.0012 At most 5 * 0.544069 65.62317 63.8761 0.0354 At most 6 0.437386 41.27533 42.91525 0.0723 At most 7 0.348839 23.44533 25.87211 0.0973 At most 8 0.279134 10.14638 12.51798 0.1207

Trace test indicates 6 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level **MacKinnon‐Haug‐Michelis (1999) p‐values

Frank Iyekoretin Ogbeide , Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 4.2 Discussion of Empirical Results The empirical estimates are insightful. From the results, the ECM coefficient carries the correct sign and is statistically significant at 1 percent with the speed of convergence to long-run equilibrium remarkably high at 78.5%. This implies that 79% of the disequilibrium in the previous year converges back to its long-run equilibrium in the current year. Our results from the ECM (discussed here) and OLS techniques are broadly similar, though significance levels of parameter estimates differ considerably. Both models are free of first order autocorrelation judging by the DW statistics, but the explanatory power of the model, measured by R2, is higher in the OLS than the ECM analysis.

Table 7. Results from Empirical Models

Dependent Variable: D(LUNEMP) Dependent Variable: LUNEMP Method: Least Squares Method: Least Squares Sample (adjusted): 1982 2013 Sample: 1981 2013 Included observations: 32 after adjustments Included observations: 33 HAC standard errors & covariance (Bartlett ker- nel, Newey-West fixed bandwidth = 4.0000) Variable Coefficient t-Statistic Prob. Variable Coefficient t-Statistic Prob. C 0.093 1.267 0.219 C 4.754 1.208 0.239 D(LGDPc) -0.758 -1.085 0.290 LGDPc -1.813 -2.420 0.024 D(LCPI) -0.344 -0.904 0.376 LCPI 0.278 0.863 0.397 D(LCPS) 0.454 2.060 0.052 LCPS 0.891 4.760 0.000 D(LCUR) 1.050 2.098 0.048 LCUR 1.797 3.670 0.001 D(LEXR) -0.546 -4.202 0.000 LEXR -0.240 -1.913 0.068 D(LFDI) -0.124 -1.483 0.153 LFDI -0.324 -1.912 0.068 D(LGCE) 0.055 0.368 0.717 LGCE 0.103 0.263 0.795 D(LNRR) 0.740 3.151 0.005 LNRR 0.813 2.414 0.024 D(LTRD) -0.491 -2.752 0.012 LTRD -0.720 -2.081 0.049 ECM(-1) -0.785 -4.498 0.000 R-squared 0.752 R-squared 0.861 Adj R-squared 0.634 Adj R-squared 0.807 F-statistic 6.380 (0.000) F-statistic 15.864 (0.000) Durbin-Watson (DW) stat 1.633 Durbin-Watson(DW) stat 1.854

Private credit (CPS) carried a positive sign and is significant at 5% level, indicating that increases in the credit to the private sector lead to higher unemployment in Nigeria. The result may be counter-intuitive, but the finding may be inferred from the negative relationship between financial development and economic growth found in some studies, such as Ram, (1999); De Gregorio and Guidotti, (1995). Most credits by formal financial system are mainly offered to large multinationals in trading and servicing often with foreign affiliations, and such firms en- gage in massive profit repatriation to host countries. In turn, less credit is usually supplied to core productive sectors, like agriculture and other small and medium scale firms, often referred to as engine for growth, and with known beneficial value chains. The coefficient representing growth in natural resource rent (NRR) was positive and significant at 1% test level, indicating

Frank Iyekoretin Ogbeide, Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 that increases in NRR raises unemployment. This result reinforces the resource curse argu- ment, even so resource wealth has been found to cause of economic stagnation, corruption, and civil war. Similar result can be implied from studies by Sachs and Warner, (1995); Sala-i- Martin and Subramanian, (2003); Oyefusi, (2007); and Mehrara and Rezaza, (2011). The real GDP showed a negative and not significant impact in the ECM, but significant at 5% in the OLS estimation, thus confirming the theoretical Okun’s law. As expected, the coefficient of FDI was negative, which accentuate the spillover benefit of FDI on economic growth, as it creates job opportunities see also Chang (2007). Inflation negatively relates with unemployment rate, though not significant at the conventional tests levels, but provides evidence of the existence of the Phillip’s short-run relation. Manufacturing capacity utilization was seen to aggravate unemployment rate. The result shows that increases in manufacturing sector’s capacity usage intensity worsens unemployment trajectory, thus indicating that Nigeria’s unemployment may be due to factor of production choice. Such that, adopting capital-intensive strategy, amidst surplus labour will culminate in higher levels of unemployment. Government capital expenditure (GCE) worsens unemployment situation, providing evidence of rent-seeking behaviours. With evident abuse of office via corruption, public officers tend to accumulate political capital, rather than socially productive ones, thereby eroding the benefits and potency of poverty reduction strategies. Result is similar to conclusions by Mauro (1998), Fosu, Bates and Hoeffler, (2006), Kimenyi (2007) and Ogbeide and Mustapha, (2013). The coefficient of exchange rate (EXR) was found to be negative since the Naira’s depreciation discourages imports, but encourages local production, thus can potentially reduce unemployment. More so, the coefficient of trade openness was also negative; suggesting that openness of a country to trade can have an effect on economic activities through diffusion of technology into the domestic economy.

4.3 Stability Analysis The study examined the stability of the parameters in the short-run unemployment model using the plots of the CUSUM and CUSUMSq. The results of the two tests are provided below. Basically, the existence of parameter instability is established if the CUSUM and CUSUMSq of residuals go outside the bands represented by the two (dotted) lines at 5% critical level. While the CUSUM test is suitable for detecting systematic changes in the regression coefficients, the CUSUMSq is utilized in situations where the departure from the constancy of the regression coefficients is haphazard and sudden (Adebiyi, 2004). From the graphs presented, only CUSUMSq, shows stability of parameter throughout the study period. CUSUM, however, wit- nessed a systematic divergence in 1998, which the Chow Breakpoint Test further emphasized, and conclude the model is not stable since the null hypothesis is rejected. The Chow Breakpoint is reported in Table 8.

Table 8. Chow Breakpoint Test

Chow Breakpoint Test: 1998 Null Hypothesis: No breaks at specified breakpoints

Equation Sample: 1981 2013

F-statistic 8.877539 Prob. F(10,13) 0.0003 Log likelihood ratio 67.90802 Prob. Chi-Square(10) 0.0000

Frank Iyekoretin Ogbeide , Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 Figure 2. Stability Test Using CUSUM and CUSUM Sq of Residuals

-4

-8

-12

-16 92 94 96 98 00 02 04 06 08 10 12

CUSUM 5% Significance

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4 92 94 96 98 00 02 04 06 08 10 12

CUSUM of Squares 5% Significance

5. CONCLUSION AND POLICY RECOMMENDATIONS The empirically discussion in this paper reveals far-reaching findings regarding the socio- economic factors that results in labour unemployment in Nigeria. The study employed both the error-correction modeling (ECM) and ordinary least squares (OLS) techniques. Comparatively, the results from the ECM model (short run analysis) are robust to results obtained using the OLS (long-run) technique. The coefficients representing GDP and FDI, though not significant in the ECM model, were both significant in the OLS model at 1% and 10%, respectively, but both follow the Okun’s relation. Inflation had mixed performance in both models. The coefficient was

Frank Iyekoretin Ogbeide, Hillary Kanwanye, Sunday Kadiri / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 49-64 positive in the OLS model and negative in the ECM framework, suggesting the importance of good macroeconomic policy environment. Government capital expenditure was found to aggravate unemployment rate in Nigeria, though not significant in both the short-run and long-run model specifications, suggesting the unproductive nature of such spending. The study has been able to identify empirically the factors that curtail, as well as, propagate unemployment in Nigeria. Output size (measured by GDP), foreign direct investment, exchange rate depreciation, and trade openness were found to curb unemployment, while factors that worsen labour unemployment in the country include financial development (measured by private credit), intensive capacity utilisation, and natural resource rent. Government capital expenditure, though not significant, increases unemployment rate in the country, due perhaps to weak institutional quality. Hence, to enhance public expenditure management, therefore, economic planners should implement efficient ways of understanding the impact and response lag of macroeconomic variables to public expenditure to minimize the waste in public resources. The low private credit/GDP ratio to the core of the economy has dire implication for real sector growth and employment in the country. To this ends, this study recommends that government should consciously adopt economic framework in line with the unique structure of the economy, with particular emphasis on domestic production that relies on internal sourcing of raw materials in sectors with linkage effects. Also, policy makers in Nigeria should promote lending to sectors with potentially beneficial value-chains, such as agriculture to boost labour force participation and employment. This pre- supposes the need for effective monitoring/supervision of the interactions between financial institutions and macroeconomic policies to further improve resource-use efficiency. Thus, improving access to more diversified financial services/products induced by policies of financial reform would support inclusive growth, as well as stimulate higher levels of productive activities. Institutional arrangement should also be strengthened, including the need to ensure that natural resource wealth is used to generate other forms of capital, like human capital, physical capital, and financial capital, to engender upward spiraling economic growth equilibria in Nigeria.

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Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77

Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 65-77 ‘

Social Entrepreneurship in Romania: Significance and Models

Cătălina Mitra CriȘan1, Dan-Cristian Dabija2, Vasile Dinu3

1 Babes-Bolyai University, Cluj-Napoca, Romania, Faculty of Economics and Business Administration Department of Management, e-mail: [email protected] 2 Dan-Cristian Dabija, Babes-Bolyai University, Cluj-Napoca, Romania, Faculty of Economics and Business Admini- stration Department of Marketing, e-mail: [email protected] 3 Vasile Dinu, Bucharest University of Economics, Romania, Faculty of Business and Tourism Department of Busi- ness, Mihai Eminescu Building, e-mail: [email protected]

ARTICLE INFO ABSTRACT Received Aug. 11, 2015 Approach: Social entrepreneurship is a complex process that pro- Received in revised from Oct. 27, 2015 vides solutions to the most complex contemporary issues of our Accepted Nov. 29, 2015 society. Nowadays, more and more organizations use this form of Available online Dec. 03, 2015 market approach when seeking to help less fortunate people, by providing unique benefits and by gaining the upper hand on a com- JEL classification: petitive level. In many cases, the impact of these organizations on I31, I32, M14 target markets is undeniable, confirming the sustainable and critical nature of this process oriented towards solving social problems DOI: generated by: excessive resource consumption, environmental pollu- 10.14254/1800-5845.2015/11-2/4 tion, increasing number of social assistance, discrimination against people with disabilities and vulnerable groups etc. Keywords: Purpose: In the article, the authors provide an overview of the cur- Social entrepreneurship, rent state of social entrepreneurship research, offering baseline Social enterprise, data on the state of social entrepreneurship in Romania. Even in the Social value, process, most austere environments, anyone possessing creativity and de- Social problems termination can dare launch social enterprises. Methodology: Supporting the theoretical premises of the literature, the authors turned to a qualitative empirical research, which they conducted with the help of an interview addressed to representatives of 1.418 organizations. Findings: Pertinent conclusions are drawn, thus increasing relevance both in terms of theoretical and practical aspects. Our research results function as a benchmark for further approaches in the field of social entrepreneurship and facilitate a better understanding of social entrepreneurship rates in Romania.

1. INTRODUCTION At a time when we cannot speak of economic progress and sustainable development without referring to the social value of an entity, responsible behaviour and social-oriented management become benchmarks for any organization that seeks proper market positioning and best ways to meet customers’ needs. As private companies exert a growing influence on the 65

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 market, increased consideration of reasonable behaviour and ethical principles should be supported in order to avoid the devastating effects of unethical practices on society at large (Dinu, 2008). Both public and private sectors must treat the sustainability issue holistically, establishing a balance between the quality of lifestyle and the responsible consumption of resources (Dabija, Băbuţ, 2013). The sustainable development of a society may be possible by encourag- ing organizations that are actively involved in addressing the root causes of social problems, such as social enterprises, non-governmental organizations with social missions and companies through CSR policies (Crian, 2013). More and more researchers believe that social entrepreneurship offers a range of tailored- made solutions to problems faced by contemporary society (Austin et al., 2006; Mair and Marti, 2009; Mair et al., 2012; Dees, 2007; Ţigu et al., 2015; Zahra et al., 2009). Excessive use of resources, environmental pollution, the increasing number of socially assisted persons, discrimination against people with disabilities and vulnerable groups due to insufficient integration alternatives etc., are some of the current challenges of the world we live in today. Notorious examples such as the Grameen Bank and Cafedirect come as a confirmation of theoreticians and practitioners’ opinions of social entrepreneurship. The term "social entrepreneurship" was first used more than forty years ago by Banks (1972), when it echoed a social movement initiated by social innovators, due to social conditions on the existing market. The growing popularity of social entrepreneurship was reinforced by the inclusion of its study in educational curricula of prestigious universities in the USA, such as Harvard Business School, Stanford University, Columbia Duke, New York University (Dees, 2007). Social entrepreneurship in general and its forms of manifestation in particular (practical strategies of implementing it) have become the focus of reputed research centres hosted both by higher education institutions and by companies (Tracey and Phillips, 2007; Smith et al., 2012; Cheben and Lancaric, 2012; Munteanu et. al., 2014; Bartoš at al., 2015; O'Leary, 2015). The issue of social entrepreneurship has been extensively studied in recent years, its theoretical approach being often based on various current examples of best practice commonly used by various organizations. This paper aims to confirm the dynamics of the social entrepreneurship and to present the features of this phenomenon on the Romanian market. For this purpose, the authors report the most representative approaches that support the complex structure of social entrepreneurship, referring to the fact that the initiative to create social value through this process may be the prerogative of local authorities, of various non-profit, but it can be also the result of private initiatives, of ordinary people. Although non-profit organizations are most likely to promote social entrepreneurship, it is considered that any initiative for implementing this process can happen only if there is determination, creativity and solidarity with the most vulnerable groups (Drăguin et al., 2015). Due to the undeniable benefits offered, social entrepreneurship is essential in a sustainable development of modern society, and organizations acting in accordance with these principles certainly deserve their status of examples, perfectly capable of turning social problems into business opportunities. To confirm this view the authors provide an overview of social entrepreneurship in Romania, by performing an empirical study designed to highlight the general features of social involvement of and NGOs alike (that could be taken as promoters of social entrepreneurship processes). Likewise, to provide an even clearer image of social entrepreneurship, the authors will present three standard examples meant to illustrate different aspects of local social enterprises that have managed to adequately adapt to a shifting environment, characterized by a continuous change in terms of economic, political, social, and especially legislative aspects, and basically managing to face the many challenges.

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 2. SOCIAL ENTREPRENEURSHIP – COURSE OF ACTION SUPPORTED BY SOCIAL ENTERPRISES A delimitation of social entrepreneurship from the general concept of entrepreneurship is justified by the recent specialized literature, through the possibility of creation and development of social enterprises (Mair and Marti, 2006). These hybrid entities that combine social economic principles in a new revolutionary way are in fact focused on providing services for their communities (Pomerantz, 2003), for the ones facing various challenges (social and demographic difficulties, the standard of living etc). According to Schwab Foundation for Social En- trepreneurship (Schwab Foundation for Social Entrepreneurship, 2010), social entrepreneurs resemble, to some extent, commercial entrepreneurs because in both cases the key challenge is to create self-sustainable organizations with the mission to solve social problems and not to make profit. According to Kramer (2005), the social entrepreneur is the equivalent of a person who creates and runs an organization that can be oriented towards achieving profit or not, focusing on the innovative nature of its business, introducing new methodologies, manufacturing systems that are revolutionizing the field of activity, etc. Social entrepreneurship is considered to be an innovative policy of public management designed to “heal” the shortcomings of the social system within a country (Prahalad, 2005;). This approach is oriented towards the welfare of individuals, aiming to generate social added value (Lewellyn et al., 2010) and social cohesion (Di Domenico et al., 2010). Social entrepreneurship can be triggered by economic initiatives carefully designed to correct existing market failures translated into a lack of jobs, lack of future perspectives for people with disabilities, ethnic discrimination, poverty, etc. It should be able to provide sustainable perspectives for solving real problems to which public systems of social protection have not yet found a solution (Wallace, 2007). Furthermore, Dees (2007) believes that social entrepreneurship is an integral part of a process that continuously reinvents itself by offering alternatives to local communities, to the state and to different companies, for various troubles the society is facing. Kauffman Foundation (2010) includes in the category of social entrepreneurship organizations that are primarily focused on generating profits for social purposes. Including commercial activities in the social entrepreneurship process increases the chances that this process will be, on a long term, a viable and self-sustaining one. More and more researchers are linking social entrepreneurship to a specific phenomenon within the non-profit sector (Taylor et al., 2000). Non-profit organizations bring their indirect contribution to economic growth, especially by liaising different entrepreneurial approaches and strategic investments in solving various social problems (Bahmani et al., 2012). In doing so, the organizations manage to improve areas and conflict aspects, especially those that are “hard to manage” by the society. In fact, these approaches can create jobs, increase social welfare by actively involving community members in various activities, attract individuals towards training courses and education etc. In this way technological process and innovation are encouraged, stimulating the development of those communities that are able to implement such measures, with a direct impact on the social, economic, educational aspects within a specific area (Abramovitz, 1989; Nicolescu and Nicolescu, 2012). More and more authors consider that in the absence of an efficient mechanism able to generate revenues for organizations with a social mission, sustaining their mission will become increasingly difficult (Wallace, 2007; Moss et al., 2011). In order to gain financial sustainability, non-profit organizations are keenly getting involved in initiating various sustainable innovative entrepreneurial approaches, such as creating and selling goods or services that add value, which are meant to promote social change (Mair and Marti, 2009; Marshall, 2011; Zahra et al., 2009). Social entrepreneurs can be considered activists of the social cause that manage to recon- figure the way resources are used in order to achieve specific results directed to solving social 67

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 problems (Pearce, 2003). Taking into account the innovative steps taken by an organization to address social problems, it can be said that between social entrepreneurs and commercial entrepreneurs, there is only a small difference given by their mission statement (Arend, 2013). Thus, while social entrepreneurs envision mainly charitable and philanthropic actions, commercial entrepreneurs are primarily focused on economic activities measured by financial results. However, in both cases, getting a monetary equivalent surplus remains essential, fully justified by the need for further investments dedicated to supporting the activities that contribute to meeting the targets of the organization. Thus, the binary structure of the social enterprise going hand in glove with predefined social objectives is influencing the strategic approach of share- holders, internal and external customers. Social entrepreneurs act as agents of social "change" (Nicholls, 2006), guided by different ethical principles and behaviours (Drayton, 2002), in order to increase the accountability of local communities and to find the best solutions to identified social problems (Yunus, 2008). Besides promoting a specific social-oriented mentality, the social entrepreneur must fully ac- knowledge the benefits of a type of business which aligns its activities to its targets. Important elements that may prove useful could refer to: adequately addressed social problems, transparency of decisions taken, corroboration of social mission with the organization culture, properly generated monitoring and measurement of social impact, invitation to permanent innovation, and foundation of intra-organization capacity to generate viable self-sustaining and self- regulating mechanisms according to market trends.

3. RESEARCH METHODOLOGY Numerous published studies on social entrepreneurship and the role that it continues to hold in modern society demonstrate the growing interest in this topic. Different authors conclude that this form of entrepreneurship can decisively influence society and its progress (Mair and Marti, 2006; Nicholls, 2006; Perrini, 2006; Gawell, 2013; Abrham at al., 2015; Belas at al., 2015). This is a pilot study based on pioneering work designed to highlight the main directions of social entrepreneurship in Romanian organizations, with the help of an empirical study (interview guide) and the case study technique. In order to meet this goal, the authors have ap- proached 1,418 organizations (associations, foundations and limited liability companies from different fields of activity). Managers and/or other responsible individuals from the top and/or middle management were interviewed according to the interview guide developed by the authors regarding different aspects of the social entrepreneurship dimensions and activities from Romania. From the 1,418 companies contacted for the interview only 185 could be answered favourable, which means that the response rate is of 13.04%. Although this is quite low, due to the complexity of the studied problem and the topic addressed, the results can be very well generalized and clear strategies might be highlighted. The selection of the surveyed companies was preceded by a close investigation of those organizations that have applied measures of social responsibility, and are focused on caring for vulnerable people, the environment and civil society from the north-western part of Romania. All contacted companies were either listed in the database of the Romanian Ministry of Labour, the Romanian Child and Social Protection Service, as well as from a private subscriber list, with open access on the website. The limits of this study are given by the small number of respondents from the private sector, which stems from the top managers’ lack of readiness and of social awareness, low number of top managers etc.

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 4. RESULTS OF THE RESEARCH 4.1 Analysis on the premises of ensuring the social entrepreneurship in Romania The evaluation of social entrepreneurship in Romania was made by contacting over 1,418 organizations, from the non-profit and commercial sector. This empirical research is based on 185 responses that had been validated, out of which 53.51% were represented by associations, 25.95% by foundations and only 20.54% by companies. Fields of activity vary considerably (sport and leisure, tourism, education and counselling, religion and culture, production, trade, different types of services), the questioned managers indicating between one and seven major domains that generate revenue for the organizations they represent. While 27 managers did not indicate any major field of activity generating the biggest part of their revenue, 55 organizations are focused on one field only, 36 on two, 45 on three, 3 on four fields, 10 organizations on five fields, 8 on six, and only one focused on seven fields of activity. Interestingly enough, it appears that, in general, the associations are active in several fields (Table 1). Most of them are active in counselling (36 associations), arts (24 associations), health (22 organizations) and environmental protection (21 organizations). The main areas of activity of foundations included in the sample seems to be counselling (24 foundations) and education and training (15 foundations), while respondents from the two companies are active in the religious field.

Table 1: Fields of activity of studies organizations (own research)

Organizational Form Field of activity Companies Foundations Associations Total n % n % n % n % Art 1 0.25 2 0.50 24 5.99 27 6.73 Religion 2 0.50 4 1.00 6 1.50 12 2.99 Sport and leisure 4 1.00 1 0.25 11 2.74 16 3.99 Child care 1 0.25 5 1.25 16 3.99 22 5.49 Health 1 0.25 6 1.50 22 5.49 29 7.23 Education and training 4 1.00 15 3.74 76 18.95 95 23.69 Tourism 6 1.50 1 0.25 14 3.49 21 5.24 Media - - 1 0.25 1 0.25 2 0.50 Environment protection - - 2 0.50 21 5.24 23 5.74 Recycling - - 1 0.25 9 2.24 10 2.49 Agriculture 1 0.25 1 0.25 8 2.00 10 2.49 Counselling 4 1.00 24 5.99 36 8.98 64 15.96 Trade 9 2.24 1 0.25 8 2.00 18 4.49 Production 5 1.25 8 2.00 4 1.00 17 4.24 Financial services 8 2.00 - - 5 1.25 13 3.24 Employee rights 3 0.75 - - 1 0.25 4 1.00 Transport - - 7 1.75 11 2.74 18 4.49 Total 49 12.22 79 19.70 273 68.08 401 100

The geographic area of actions of the entities within the sample vary a lot, being both local (76 organizations), and international (23 organizations) – Germany, Austria, Belgium, the UK, Hungary, Poland, Ukraine, the Republic of Moldova etc. Analysing the range of activity of all organizations included in the sample, we notice that most organizations are active at a national level (72 or 38.92% of the sample), a significant number of which being active also internationally (42 or 22.70%). 69

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 The social orientation of the investigated organizations stands out if we take into account the number of employees working for these organizations: 123 have permanent employees, 92 have part-time employees and 92 use volunteers. As most NGOs have up to 10 employees, while only a small number can boast more than 20 employees, it follows that NGOs are not able to ensure a large number of jobs, first of all due to the limited financial resources available and temporary projects carried out. Associations appear to be more orientated on the social elements, using a relatively large number of part-time employees or volunteers. In this respect, their management may contribute to the proliferation of the social value, succeeding to a large extent to act in accordance with the principles of charity and philanthropy. This value can be reflected also in the form of job opportunities for people with disabilities. Unfortunately the number of companies that employ such persons is very low, only 2 companies indicating that they have employed people with disabilities. This only demonstrates a certain reticence towards perceiving them as a valuable asset. The chances of these people to find a job and to have a financially independent life are drastically reduced, which may actively contribute to emphasiz- ing their social problems and challenges. Another aspect that we included in our research was the importance given to the social value by businesses and NGOs, which is why we analysed the mission of the organizations included in the sample. As expected, the majority of the companies surveyed declared that making profit and obtaining innovative products/services are the most important aspects taken into account when setting their mission, while issues like pollution reduction, environmental conser- vation, job creation and social protection, are not a priority. This suggests that the businesses surveyed are focused on the development of profitable business and less on the social component of the activities undertaken. The most common words associated with the concept of social entrepreneurship were: people, business, helping the needy and charity. In the case of companies 63.15% of managers have never heard the term social entrepreneurship, while in the case of the NGOs only 21.08% of the respondents were not familiar with the concept. The increased awareness of the phenomenon has been fostered by the many European projects granted for solving social problems such as Roma inclusion, integration of people with disabilities, poverty reduction, school dropout, etc. Both in the case of the NGOs and the companies, excessive bureaucracy, legislative restrictions and mismanagement were identified as the major problems in generating social value. Most of the respondents, in the case of companies, indicated that they do target the results of social involvement, which demonstrates that CSR policies are not aimed at having a long-term sustainable impact. Analysing the nature of the aid granted in the form of social responsibility policies by the companies analysed, we observed that financial aid was preferred, but there are also companies that provide assistance in the form of counselling, employment, food and clothing and even shelter. Financial support is preferred among companies because this form of aid does not require additional effort or complex activities, thus revealing that most of the respondents do not have a long-term social responsibility policy. The actions oriented towards solving social problems have often been quite arbitrary or context-conditioned, and thus, unable to hold the core values meant to emphasize sustained social responsibility policies. Business aid is focused more on helping people with disabilities, followed by children and young people and individuals with low incomes. Segments represented by refugees and prisoners are not shortlisted by companies (Table 2). Another analysed aspect was the enterprises' predisposition to collaborate with NGOs, organizations that have the biggest chances to actively support the social entrepreneurship process. Thus we analysed the extent NGOs are seen as potential partners in the process of implementing corporate social responsibility policies as well as the NGOs’ willingness to extend relations with companies. An overwhelming majority of the respondents (81%) said that they would 70

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 not establish a partnership with an NGO in order to achieve social responsibility policies. How- ever, those who would agree to it would do so only if it were mutually beneficial, if social activities were too complex to handle, or if the social impact were greater. In the case of NGOs we notice that there is an increased willingness to support competitiveness in order to attract resources for social purposes, but the association/collaboration with other NGOs in the field is not seen as a means of increasing the performance and hence the social impact. This brings about the negative side of the issue, starting from the fact that, in the non-profit sector, social-oriented organizations should identify ways of attaining success. In this case the collaboration with organizations pursuing the same goal would increase their social impact and at the same time their efficiency. Collaborations with the industry sector are considered by the NGOs as an attractive alternative of creating value in terms of stimulating performance growth.

Table 2: Organizational forms of target groups (own research)

Organizational Form

Target Group Company Foundations Associations Total N % n % n % n % People with disabilities 3 0.53 12 2.13 44 7.82 59 10.48 Children and young people 7 1.24 30 5.33 72 12.79 109 19.36 Elderly/ retired people 1 0.18 12 2.13 23 4.09 36 6.39 People with low income 3 0.53 12 2.13 34 6.04 49 8.70 Unemployed - 0.00 8 1.42 22 3.91 30 5.33 Homeless 3 0.53 8 1.42 13 2.31 24 4.26 Minorities 2 0.36 5 0.89 5 0.89 12 2.13 Refugees - 0.00 1 0.18 5 0.89 6 1.07 Women 3 0.53 3 0.53 21 3.73 27 4.80 Drug or alcohol addicted 1 0.18 9 1.60 5 0.89 15 2.66 People with learning difficul- 6 1.07 7 1.24 11 1.95 24 4.26 ties Mentally challenged 4 0.71 17 3.02 37 6.57 58 10.30 Prisoners / Ex-convicts - 0.00 3 0.53 7 1.24 10 1.78 Local Community 3 0.53 14 2.49 62 11.01 79 14.03 Environment - 0.00 3 0.53 22 3.91 25 4.44 TOTAL 36 6.39 144 25.58 383 68.03 563 100.00

At the NGO level we have identified a problem of transparency, most respondents stating that data regarding the activity carried out can be accessed by any interested group, but a relatively high proportion (64%) said that such information is available after obtaining the consent of certain people within the organization. Another aspect that brings distrust into question is the fact that access to financial information, useful in identifying ways of using financial and material resources, is often conditioned by filling in request forms that need management consent.

4.2 Good practices in social entrepreneurship An adequate understanding of the phenomenon of social entrepreneurship cannot be sepa- rated from the consideration of practical experiences, situations or specific cases in which social enterprises succeeded in promoting the social mission for which they were created. To put this material together, the authors prepared an overview of several examples of social entrepreneurship in Romania. In general, social entrepreneurship and accurate forms of manifestation of this are somewhat at the beginning, there are no established models or a coherent 71

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 strategy at play. We have organizations that managed to implement their approaches to social entrepreneurship as a result of their abilities in identifying concrete means to exploit some niche situations. For certain areas in Romania, social entrepreneurship facilitated a spectacular development of the local communities that were at the subsistence level. Due to a proactive involvement in the Roma community and to providing initial capital consisting of a minimum amount of resources, the beneficiaries of the social entrepreneurship project have not only been able to improve their standard of living, but also to take part in self-sustaining activities. Of course, through this approach, local communities were supported by specialists from various foundations, and by the Romanian people, Hungarians and Saxons living in the neighbouring areas (MediaInfo, 2011). In 2004, at the initiative of the American Foundation Heifer, Romas in the village Nema Sibiu, were given the chance to choose a better life and social prosperity (Heifer, 2008). Before the actual start of the project, community members participated in training courses organized by the Resource Centre for Romas Communities and Heifer Romania. To facilitate the access of the community to a constant source of food and income, the foundation offered them about 200 goats. Each family received between five to six goats, with the obliga- tion to donate the first billy goat to other disadvantaged people in their community. This initiative has allowed the families to understand that only by acting together can they become effective entrepreneurs, can they learn the secrets of charity and are they able to work together to increase the value of shared goods. Program beneficiaries were organized into a cooperative farm in order to manage the pasture needed to ensure food for goats from each family. Be- cause community members did not have the necessary parcels to cover the needs of food, they enlisted for the help of the local city hall, as well as some local benefactors. Implementing this entrepreneurial endeavour did not come without its difficulties and challenges. In fact, tensions sparked off when goat milk production exceeded family consumption, the excess being difficult to capitalize on the market for various reasons (Romanians’ reticence to buy milk from Romas – considered to be dirty – or the price per litre – considered to be too high). Consequently, the beneficiaries of the program had to identify other sources of income from the sale of billy goats, animal breeding, contributing to the perpetuation of the French Al- pine goats etc. (Adevărul, 2011) Also, eight beneficiaries have joined into a cooperative and have built up a farm on the outskirts of the village with the support of the Foundation and some locals. Another remarkable thing is the fact that the community members who built the cooperative gave up the financial support of a foundation focused on Roma communities, the money saved being redirected to the local school and to other community projects. Closing down orphanages in Arge county increased the number of children with disabilities, to which the public education system did not offer a viable prospect for professional or personal development. Following an accident suffered at the age of 23 which laid him up for two years, a local entrepreneur decided to create support centres for people with different social needs. Together with Soros Foundation Emergency Fund, the young entrepreneur has established several charitable organizations, HAND-ROM Foundation, "Marina Day Centre", "Sf. Paraschiva" Centre, pre-professional training workshop DizabRom (Argeexpres, 2013). Thanks to a very in- spiring motto "From assisted assistant - I succeeded and you can too!" people with social problems or from orphanages are encouraged to gain financial independence, to pursue various training courses or learn some crafts (candle-making, etc.), to learn how to adapt to the present working and living conditions, to learn the skills and abilities necessary for a normal life. Fur- thermore, the integration of all these people in society is sustained by interaction with people in the community through established programs organized in collaboration with various companies (Hand-Rom, 2014). Such products are marketed in the various fairs and events with religious themes through a commercial company (Nicosmail, 2014). Following the laying off of more than 95% of employees from the steel plant Mechel in Câmpia Turzii, the local authorities were faced with extreme unemployment (unemployed 4,800 72

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 out of 26,000 inhabitants). They obtained a four million euro financing of a social enterprise focused on producing ski overboots, respectively for the training and retraining of young employees (Ziarul de Cluj, 2013). Although the new social approach created only 250 jobs, the initiative has proved successful, mainly because, when finalizing the project, employees are given the opportunity to become owners of the company (România Liberă, 2014). This approach aims not only to achieve sales of products and to ensure the sustainability of the company on this highly competitive market, but also to solve the social problem of the city, due to the rein- vestment of a significant portion of profits in the company. The major innovation of the new social enterprise is that it is composed of four different associations. While three of them will produce the raw materials required to manufacture overboots, the fourth manages the entire process, ensuring relations with the markets and customers. Additionally, besides manufacturing textiles, the project envisions the production of metal and wooden objects, as well. The project scheduled a series of professional training courses for 250 people and retraining for 138 others who were subsequently employed in various businesses. Companies that hire qualified unemployed people through this program also received certain grants of up to 5,000 Euros. At the same time, re-qualified people have a chance of accessing funding of up to 15,000 Euros for the implementation of different business ideas.

5. DISCUSSIONS Social entrepreneurship proves that through ingenuity and innovation and by being dedication and performance-oriented, you don't need to be a successful manager in order to be able to generate added value. Instead, a clear, well defined strategy is needed and it must be in accordance with the objectives and resources at hand. Despite the major influence that social enterprises can have over society, both socially and economically, in Romania, this phenomenon continues to face many obstacles and problems. Currently, there is apathy among companies and NGOs in promoting social entrepreneurship, the field being into an early stage of development. Lack of transparency, excessive bureaucracy, reluctance to collaboration, desire to gain high benefits from projects aimed at supporting social entrepreneurship, are some of the impediments that delay the propagation of the phenomenon in Romania. Lack of legislation and delays in adopting Social Economy Law (L.14/2014) Social Entre- preneurship initiatives are difficult. Accordingly, social entrepreneurship (social economy) is identified by the social relations established in order to fulfil the public interest and sustainable development, in order to sustain full social cohesion and integration. The law clearly states that at least 30% of the employees must belong to a vulnerable group, at least 50% of the profit must be reinvested in the company's activity and the social enterprise activities must be consistent with the objectives of the county development plan (Proiect de Lege Economia Socială, 2014). The implementation of the law is, in our view, absolutely necessary, because it precisely regulates the intervention on vulnerable groups and provides a more accurate perspective on the implementation of social entrepreneurship in different organizations. Representative examples of good practice demonstrate that for both the profit-oriented organizations, and for those where generating profit is not the central element, social entrepreneurship ceases to be an isolated case and becomes a primary vector generating competitiveness and entrepreneurial performance. We can argue that social entrepreneurship is a wide- spread phenomenon in different Romanian organizations, whose dimensions expand yearly, causing major changes in daily life, significant changes in companies, and giving those who want to improve their market position a new way of approaching the target markets. Of course that for a proper implementation of social entrepreneurship, a prerequisite is that the direct beneficiaries of these measures are not indifferent to the support or aid and are able to understand the need for an active involvement. They need to be aware of their own actions, which

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 ultimately contributes not only to their own welfare, but to uplifting the entire community to which they belong. The major contribution in Nemsa social project consisted in changing the mentality of the inhabitants in the area, enabling them to understand that change can be achieved only if they agree to change their opinions, perceptions and approach to different daily situations. Although the primary purpose of the project was to ensure basic means of living for the Roma community, facilitating their integration into the local community, the project enabled also entrepreneurial initiatives with a major long-term social impact. In addition to educating beneficiaries, the project offered entrepreneurial advice and also tried to properly educate the Roma, thus endow- ing them with better use of knowledge, skills and abilities acquired, in viable projects for their own welfare and of community's. Nemsa case clearly demonstrates that without an integrated view on the potential development of disadvantaged communities and active involvement of people to change their mentality, any counselling program, project, and private institutional approach are doomed to failure. Only by focusing on key issues for long-term success, such projects are viable and can be successfully implemented even among disadvantaged Roma communities. Without participatory involvement, will, determination, dedication, proper counselling, long-term vision and of course financial resources, social entrepreneurship initiatives are not sustainable and do not cause major effects on long term, probably just specific solutions to some problems of the communities. In other situations, such as the social enterprise established for former employees of the Mechel Câmpia Turzii or the initiative Dizab-Rom, a challenge is to attract funds to generate useful long-term benefits. Although the structure of social enterprises helps attract alternative sources of income (donations, sponsorships, grants, etc.), the major challenge for these initiatives is adapting to the realities and challenges of the market economy. Survival and especially their development depend on the ability to enact these initiatives and to become competitive, to benefit from the intellectual contributions of smart entrepreneurs and to be able to adapt to any conditions, and to have the capacity to innovate and upgrade the approaches implemented. Basically, the main objective of any business initiative is to attract or generate investment funds, which of course, due to the social mission, could lead to searching for alternatives, including grants. We rightfully appreciate that, in order to record more examples of successful social enterprises, new approaches are that are able to combine the innovative financial and economic objectives with social ones are required.

6. CONCLUSIONS In terms of an adequate legal framework, social entrepreneurship can be extremely effective in fighting various problems, especially challenges facing society on a whole (pollution, poverty, illiteracy, global warming, etc.) or some local communities (lack of infrastructure, inequality of opportunity, etc.). Certain differences from country to country in terms of economic, social, cultural and economic background are reflected in the forms of manifestation of social entrepreneurship initiatives, which surfaced some peculiarities at both a local or a regional level. The legislative framework in Romania, although relatively large, doesn't clearly establish the con- tents of the process, leaving room for many subjective interpretations or possible confusion. The vast majority of practitioners in Romania manage to guide the implementation of social entrepreneurship initiatives following some models already validated in several other countries, but the market conditions are totally different. For this reason, for lack of appropriate structures able to support the process of social entrepreneurship, their initiatives often fail to materialize in viable functional mechanisms, being doomed to failure on a longer term. Thanks to the reputation that social entrepreneurship in Romania enjoys, there is a more intensive orientation towards attracting European funding from the implementation of various

Cătălina Mitra CriȘan, Dan-Cristian Dabija, Vasile Dinu / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 65-77 initiatives. The underlying motivation of entrepreneurial approaches is essential, since such projects are able to generate new jobs, ensure financial support for daily life, and beneficiaries can become more empathetic, they can relate better to people who have different social issues etc. A possible problem caused by such social initiatives is the lack of personalized advice provided to ensure sustainability and continuity in implementing these programs. A relatively large number of such initiatives are not feasible on long term, organizations abandoning them once funding ends. Combining social goals with business practices - as the social mission is paramount - can affect the economic performance of social enterprises. It is therefore imperative to have an adequate corroboration of the mission and strategy of socially responsible organizations with a strategic focus on organizational skills. In an attempt to adapt to market needs, some businesses drift from the mission formerly established. That is why maintaining the values that contributed to the initial position of social enterprise becomes essential. Failure in most cases derives from the desire to get the material upper hand, which undercuts the initial social- oriented principles.

Acknowledgment This work was co-financed from the European Social Fund through Sectorial Operational Programme Human Resources Development 2007-2013, project number POSDRU/159/ 1.5/S/134197 „Performance and excellence in doctoral and postdoctoral research in Roma- nian economics science domain” and by a grant of the Romanian National Authority for Scien- tific Research and Innovation, CNCS – UEFISCDI, project number PN-II-RU-TE-2014-4-0312.

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Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100

Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 79-100 ‘

Using Marketing Approach to Respond to Internationalization Challenges and Changes in Marketing Channels

Sasa Veljkovic1, Zoran Bogetic2, Dragan Stojkovic3

1 Assoc. Professor, University of Belgrade, Faculty of Economics 2 Assoc. Professor, University of Belgrade, Faculty of Economics; e-mail: [email protected] 3 Assist. Prof. University of Belgrade, Faculty of Economics

ARTICLE INFO ABSTRACT Received May 27, 2015 Notable business operations internationalization and changes in Received in revised from Oct. 11, 2015 marketing channels have affected the position of domestic suppliers Accepted October 16, 2015 and domestic brands. This is especially characteristic for the develop- Available online 30 Dec. 2015 ing countries’ markets, primarily with respect to consumer’s goods markets, where, as a rule, marketing channels are more developed JEL classification: and brand is more prominent as a means of competitive advantage. M31; L25; L81 Under competitive pressure, many companies have started to implement modern marketing approach in their business operations in DOI: order to adequately respond to the perceived tendencies. A research on suppliers’ (producers and distributors) marketing practice was 10.14254/1800-5845.2015/11-2/5 conducted using a sample of 93 companies focused on consumer

goods market from Serbia and Montenegro. Marketing approach was Keywords: observed from the aspect of the following dimensions: company’s Marketing practice, innovativeness, company’s differentiation, brand positioning and Marketing strategy, protection, developing good relations in marketing channels, perceiv- Marketing channels, ing the price as the reflection of brand value, and balanced applica- Internationalization, tion of promotion instruments. The results showed that implementa- Brand tion of modern marketing practice leads to more successful business operations and better financial results. It was also determined that, depending on the origin of (the majority) company ownership, there is a statistically significant difference in implementation of modern marketing approach. Foreign companies more consistently implement modern marketing practice in business operations. With respect to differences in companies’ market approach depending on the origin of the key brands no statistically significant differences were noted.

1. INTRODUCTION Globalization of economic environment has a strong impact on companies in Serbia and Montenegro. This process has especially affected particular product and service categories and also companies that do business in those particular categories. Domestic producers reacted differently to the pressures from abroad. Some offered resistance on the domestic market, others strived for internalization themselves, and yet others compacted into a narrow market niche or abandoned building of a strong brand and undertook intensive short-term sales promotion activities striving to keep their market share and survive on the market at all costs. A large num-

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 ber of companies and brands changed ownership. Some ceased to exist under their former names, while others kept their recognizability and brands both in a local framework and also in a wider context. Together with notable globalization and internationalization which bring global retailers to the developing countries, the concentration of retailers’ capital also takes place, and ever larger regionally important retail chains also arise. This dramatically changes the position of suppliers at consumer goods market, especially of the local suppliers. On the one hand, local suppliers bear the pressure coming from modern retailers, who have a strong negotiating position and numerous options at the regional and world market. On the other hand, the suppliers in Serbia and Montenegro also have important partners in traditional retailers who, even though they play defensively, still control a large part of the market. In the conditions of market stagnation, the suppliers in Serbia and Montenegro face exis- tential challenges: they must adequately respond to more and more prominent competitors, primarily from abroad; they must adapt to retailers and final customers; and they also must adapt to market conditions and regulations. Marketing approach to business has been the focus of attention of theoreticians and practitioners for many years now. Although the concept has significantly evolved with time, it appears as if many companies in Serbia and Montenegro have not mastered even the early phases of marketing philosophy of running a business, and they also seem to be far from grasping its modern concept and practical implementation. For this reason, the objectives of this paper are to explore and investigate the extent to which implementation of modern marketing approach to running a business leads to more successful business results, as well as whether there are differences with respect to its implementation, and in what degree, between domestic and foreign companies and domestic and foreign brands. After reviewing the relevant literature and different researches, primarily the ones concerning Serbia and Montenegro, a suitable methodological framework has been established and displayed. The main objectives and hypotheses of the paper have been defined, which have subsequently been proved by applying statistical methods of analysis and logic conclusions derived from it. Finally, the main implications for company managers, primarily managers of domestic companies, have been emphasized, and some final notes and limitations as well as possible directions for further research in this field have been given.

2. CREATING MARKETING STRATEGY IN THE ENVIRONMENT OF DYNAMIC CHANGES IN MARKETING CHANNELS AND INTERNATIONALIZATION CHALLENGES IN SERBIA AND MONTENEGRO The classic theories explaining the purpose and development of internationalization of business mainly start from Western multinational enterprises (MNEs). Pursuant to this, what is stated as the main reason for expanding outside the borders of the native country is that firms enter foreign markets to exploit their existing competitive advantages. Contrary to this, companies in the developing countries are mainly oriented to domestic and neighbouring markets. The most value-added and most profitable components of value chain are research and development and marketing (Tsai and Eisingerich, 2010, pp. 114-135). According to product (or brand) origin, all products can be divided into domestic and foreign ones. Having in mind that capital and investments increasingly move into foreign economies, either by means of buying local companies and their brands or through building one’s own production facilities, it is possible to define four basic modalities in the ‘origin and property’ matrix. The category of originally domestic brands is the clearest one, since it is the situation in which both brand origin and company ownership are domestic. Quasi-local brands are originally domestic brands bought by a foreign. It is also possible to have the situation where domestic brands have originally been produced for and presented at one particular domestic market by a foreign company. An acquired local brand is the situation in which a brand has originally been developed abroad, but it is owned by the domestic people/company. Finally, there is also a

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 situation when both a brand’s country of origin and company ownership are foreign. Global (world) brands, although they belong to the fourth described category, have a whole array of specific features and they are the products of market globalization, hence they must be observed separately (Tjiptono and Craig-Lees, 2004). Global brands are created internationally, starting with the whole world as a single market. Still, the strategy of standardized market positioning and unique elements of the brand can rarely be implemented, and it is mostly related to specific luxury brands (goods). It is more likely that the need for a specific positioning strategy will exist and, in some cases, the need will also exist for significant adjusting of the product itself to the specific market. Sometimes it even happens that the product, besides the obvious similarities in the product itself, is placed with different brand names, which is often the consequence of legal or cultural (language) barriers. A higher level of adaptation is also an option, so other marketing strategy elements, apart from some basic elements of the product itself, differ at individual markets (the manner of positioning, brand name, price strategy, marketing channels, means of communication, etc.). The highest level of adaptation comes at the end of this spectrum, where usually only the advantages in some product elements and global sources are used, while everything else is adapted to local market and consumer. The twenty-first century has brought about the need to carefully position global brands, taking maximum care about the specifics of local markets (Kapferer, 2005, pp. 319–324). This is why some authors advocate adopting a semi-global marketing strategy, which involves following different directions in different parts of the world. All of this has resulted in a greater autonomy at the local level (Douglas and Craig, 2011, pp. 82–101). In certain situations, any kind of adjustment of global brands cannot lead to adequate effects, so a company is forced to consider the option of adding some of the local brands to its portfolio. This is especially true in Europe due to both a long history and connectedness between consumers and local brands, and also due to cultural differences between individual nations and countries. This is primarily true for particular industries which are in their very nature not global in character. Namely, while global brands usually dominate areas such as car industry, luxury products, or high-tech products (computers, smart phones), it is most often the case that local brands dominate goods and services that do not require large-scope research and development at the global level, and which are a large part of everyday or periodic shopping and consumption routine. Such local brands (characteristic for the market of a specific country) have been invested in for years. They have created strong position at the market, so it is not easy even for global brands and companies to defeat them at the said market. This is a reason for considering the option of acquiring local brands. After buying a brand, one of the possible strategies is to slowly terminate and withdraw the brand from the market, but most often such brands continue to live with additional advantages brought about by having a multinational company as their owner (Veljkovic, 2010, pp. 404-409). The main advantages of local brands, due to which they could be taken into consideration as a strategic option for a multinational company, are above all the following: local brands are better suited to specific local needs; flexibility of price strategy; possibility to use local, or even private, brands to match the competitors; local brands are more easily repositioned than global brands; local brands provide a balanced brand portfolio to multinational companies; local brands provide the possibility of a quick entry at a particular market – when entering the market of a particular country a global brand, regardless of the world-wide recognition and image, has difficulties to win over both the space on shelves and in retail stores as well as the very consumers (Schuiling and Kapferer, 2004, pp. 97–112). In marketing literature, the attitude of consumers towards products coming from other countries, comparing to domestic products, is studied through the concept of ethnocentrism. By purchasing domestic products, ethnocentric consumers wish to contribute the economic development, and thereby also to the general political, social and economic well-being of a particular 81

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 country. At the same time, as opposed to them, a large number of consumers prefer foreign products, especially global brands. (Siamagka and Balabanis, 2015, pp. 66-86) Some authors suggest a sociocultural approach to purchasing local (relative to global) brands. They emphasise the importance of consumer ethnocentrism, with the remark that purchasing local brands will also depend on the effect of quality - and identity-signalling brand functions. These functions are under the influence of product category symbolism and the level of economic development of a particular country. In addition, these authors conclude that positive effects of consumer ethnocentrism on purchase of local, relative to global, brands are stronger in countries with a lower (vs. higher) level of economic development. (Strizhakova and Coulter, 2015, pp. 1-2). A significant level of consumer ethnocentrism has been determined in a large number of countries, including Serbia as well. Business subjects, organizations, associations and the government, each in their own way and with certain limitations, are all striving to use the effects of consumer ethnocentrism on strengthening of domestic products’ position in Serbia. Alongside the above stated tendencies with respect to domestic and foreign brands and companies, modern marketing channels are characterised by significant changes regarding the size of players and power (Berman and Evans, 2010, pp. 7-8, 39-41). Suppliers’ position in marketing channels has significantly changed in the developed countries in the past several decades. Their position has weakened, and the requirements for ever closer cooperation with business partners have increased (McDonald et al., 2000, p. 92). This is the source of an array of current business initiatives which represent partnership efforts undertaken together with the consumers in the function of consumer satisfaction (Kotler and Keller, 2012, pp. 519-525). The main reason for this is that retailers have become much stronger participants in marketing channels and have taken over the leading role in marketing channels in many industries. However, these changes have been much slower in the developing countries (Lovreta and Stojkovic, 2012, pp. 233-258). Retail concentration and integration have been less intensive and the retailers in these countries have not used all the benefits that modern technology brought to them. However, market saturation in the developed countries has led to retail internationalization in the developing countries (Assaf, 2012, pp. 191–205). Retail internationalization and expansion of retailers from the developed to the developing countries have forced many changes in the marketing channels of the latter. International retailers have different foreign operations modes in order to maximize time and resources allocation (Picot-Coupey, 2014, p. 976). It should be pointed out that retail internationalization is a very complex process and the retail companies have started to extensively use this strategy in the past two decades. Car- refour, Tesco, Wal-Mart, Aldi, Lidl and many other leading world retailers have opted for this strategy. Leading regional retailers are expanding as well. With internalization of business operations, the competition and also knowledge and skill transfer are intensified as well (Gereffi and Lee, 2012, pp. 24-32). International retailers lay new demands before the suppliers. Large retail companies have much stronger bargaining power and they are using it to get better conditions from the suppliers. This decreases suppliers’ margins and makes competition fiercer. This is the time of capital and information domination of retailers in marketing channels and new business conditions for suppliers. A new approach to marketing is being developed and contemporary brand management is achieving recognition (Mullins et al., 2014, pp. 38-58). The focus is on suppliers’ flexibility. Partnership is developed based on the following: strategy and tactics of key accounts management (Gosselin and Bauwen, 2006, pp. 376-385); business framework of trade marketing activities (Achabal et al., 2000, pp. 430–454); co-creation of values (Payne et al., 2008, pp. 83-96); development of customers’ enthusiasm (Coltman, 2007, pp. 301–320); shopper marketing (Shankar, 2011, pp. 29–42); modern brand management (Krake, 2005, pp. 228–238); and category management as the umbrella partnership concept (Bogetic, 2007, pp. 78-88). The common denominator to the above stated and other partnership initiatives is customer relationship management.

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 Markets of Serbia and Montenegro have been affected by the above mentioned changes up to a certain level. The purchasing power of population and market tendencies are the starting point for forming marketing channels (Levy et al., 2012, pp. 542-544). Therefore, general economic tendencies affect marketing channels. Low market attractiveness was one of the reasons for delayed internationalization of the retail market in both Serbia and Montenegro. However, low purchasing power has not stopped the changes in marketing channels of Serbia and Mon- tenegro (Lovreta et al., 2013, pp. 542-544). The following processes have occurred in Serbia and Montenegro: concentration process; changing of the roles in marketing channels; internationalization; regionalization; multi-channel competition; and development of market competition present in the developed economies (Kumar, 2012, pp. 431-516). Retail market structure is still fragmented in both countries compared to the EU average, although there are significant signs of market concentration. On the one hand, despite the decrease in market share in 2013, small grocery stores and small tobacco and liquor stores take up 33% of the market in Serbia, which is significantly more than in the Eastern and Western Europe (19% and 11% respectively). Retail concentration is higher in food retailing where the top five retailers controlled 40% of the market in 2013. In this respect Serbia lags behind Slo- venia (80%) and Croatia (55%), while it is ahead of Bosnia (37%), Romania (36%), Bulgaria (32%) and Former Yugoslav Republic of Macedonia (22%) (Cakic, 2014). International retailers are the leaders in Serbia. Belgian company Delhaize is one of the largest European retailers and Agrokor (Idea) is the leader in the Western Balkans. We should point out that strengthening of relatively strong domestic food retailers. Discounters are the symbol of revolutionary changes in marketing channels, including significant problems that the suppliers face. Discount retailers’ competition is also present in Montene- gro, primarily at the level of competition between large retail chains. Discount retail format in Ser- bia noted a significant growth, with the market share of 8% in 2013. However, this is still far below the market share of 17% of discounters in Slovenia (Cakic, 2014). This represents an opportunity for the suppliers of branded goods which have more difficulties doing business in the conditions of private brand (PB) competition (Nenycz-Thie and Romaniuk, 2014, pp. 262–269). Expansion of private brands (PBs) characterizes modern marketing channels. PB retail market share is a good indicator of the force of retailers and their brands, as well as of the position of national brands. The share of private brands in Serbian pre-packaged food market, which amounted to only 3% in 2013 (although with a tendency to increase), speaks enough of the opportunities that suppliers have in this respect (Cakic, 2014). In Montenegro, the development of competition at the level of PBs is yet to be expected. So, for example, Voli (Naš disk- ont) places a private brand Dobro, owned by Serbian DIS, thus underestimating the possible wider effects of PB. A good illustration of regional retail concentration is the pioneering regional expansion of Mer- cator which took over Rodić M&B company in 2006 and 8% of the market along with it. In 2007, Mercator took over the local company Mex in Montenegro, and in January 2008 Mercator-Mex d.o.o. company was founded with ten retail stores. Additional 77 retail stores in Montenegro were taken over by the same company from Pantomarket and Plus Commerc. In the same year, Merca- tor takes over Coka Group in Serbia (Mercator, 2015), and in 2011 it takes defensive measures by taking over Familija retail stores. Holding 19%–20% share of the food market in Montenegro in 2012 (Dmitrovic and Bodlaj, 2013, pp. 93-124), Mercator continues to expand in 2015, specifically by means of generic growth and taking over two smaller retailers chains. From the aspect of suppliers, the most important retailers’ expansions in the former Yugo- slavia occurred in 2011 and also in 2013. First, the Belgian Delhaize Group bought shares from Serbian company Delta in March 2011 whereby they set their stronghold in the Balkans and secured the leading position in the Serbian fast-moving consumer goods (FMCG) retailing. By means of acquisition of Slovenian company Mercator in 2013, the company Agrokor secured its 83

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 penetration to new regional markets (Slovenia and Montenegro) and became the largest retail chain at the territory of the former Yugoslavia. Now, Agrokor is the retail leader in Slovenia, Croatia and Bosnia, it is second largest retailer in Serbia and it also holds important strategic position in Montenegro. The leading positions in the Balkans are held by Schwarz Group, Agro- kor and Delhaize, respectively (Ryba, 2013). We can conclude that acquisitions were the main strategy to reach horizontal growth in the Serbian and Montenegrin retail market. Thompson and Crocker (2015, p. 343) argue that most new products are withdrawn from the market because their performances are not satisfactory. High product mortality combined with rising importance of private brands makes the market environment very unfriendly for new products. Chimhundu et al. (2015, pp. 49-60) discuss that manufacturer brands have a greater capacity for product innovation than private brands of retailers. Manufacturers have to use this advantage and launch more innovative products under their brands. It should be pointed out that internationalization of the supplier’s side of the marketing channels has started earlier in Serbia and Montenegro. In most (FMCG) industries, foreign companies have entered Serbian markets and have become leaders in most of them with their international brands or with local origin brands they acquired. A supplier is ‘irresistible’ when it sells the wanted brands with stable and increasing demand. This could significantly impact the markets where national brands are respected, such as Serbian and Montenegrin market. The regional and international aspects of distributing business and competition are especially emphasized in this respect. The practice of promoting regionally important brands is also part and parcel of localization of globally defined and confirmed market strategies (Carpenter et al., 2013, pp. 271-291). Key account management is, thus, realized at different levels, including the extremes of both global and local. A more widely defined strategy requires a ‘descent’, that is, a local market for concrete business results. When market is brand-oriented, it should be provided with brands as recogniz- able landmarks in the process of shopping and social affirmation (McDonald et al., 2000, p. 199). The stated structure of ownership of regionally important brands points to the conclusion that in Serbia and Montenegro there are still some companies that insufficiently understand the general importance of brand at both strategic and operative levels. On the other hand, in the sense of covering marketing channels with good quality brands, an agile relationship between multinational and regional companies is observed. Besides this agility, an active practice of portfolio innovativeness is also observed (Diehl and Poynor, 2010, pp. 312-322) in both ownership and distribution sense. Besides innovativeness in the products assortment, the importance of business innovativeness also implies innovativeness in services assortment (Vaccaro, 2009, pp. 315–330). In this sense, customer service represents a creative and developing field of prospective suppliers (Gebauer et al., 2008, pp. 58-70). A team work of suppliers and retailers on activating and satisfying a picky customer is the newest filed of brand management innovativeness at the point of sale (Kiran, 2012, pp. 1059-1066). Innovativeness in suppliers and retailers’ cooperation is also necessary with regard to suppliers’ promotional sales. This implies targeting retailers with occasional sales promotion activities in the retailers’ facilities with discounts for final customers. In any case, it is important that price discounts respect the maintainability of the brands and bring benefits to all parties involved in marketing channels (Hellman, 2005, pp. 4–11). Without partner-like cooperation, planning and realizing of price discounts, the stated business aspect becomes the area of generating losses and ineffectiveness in the entire supply chain (Bogetic and Acimovic, 2009, pp. 53-63). In order to be successful in a more competitive market, suppliers have been forced to apply modern marketing principles and strategies in Serbia and Montenegro. There are a lot of misconceptions about what is a marketing oriented company. Marketing myopia is highly present in these two countries. Marketing orientation of a company has several dimensions according to 84

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 the researched model. A marketing oriented company values its brand(s), and brand management is its priority. In order to keep products’ attractiveness, companies have to be innovative and flexible, i.e., they must be ready to meet the needs of more particular and more informed customers. The price should be compatible with the product quality, as well as with overall positioning strategy. Integrated marketing communication strategy should be implemented in order to successfully reach target market. Partnership perspective in marketing channels is dominant. The specifics of general economic conditions must also be taken into account. They could impact the effectiveness of both brand advertising and brand pricing. The short-term price and advertising elasticity do not change with the business cycle, which is not the case with elasticity in the long-run. The effects that price and promotion have on each other, and also on the effectiveness of business operations and brand position, depend on both economic conditions as well as on major product classes and brand type (premium mass brands, value mass brands, premium niche brands, and value niche brands). Pursuant to this, but also depending on the set marketing goals, the companies’ marketing strategies will also differ (Van Heerde et al., 2013, pp. 177-193). Brand management process within the framework of a company’s entire business and marketing strategy implies an adequate response to contemporary conditions of doing business. In the past several years, economic downturns, brand proliferation, and media transformation have been extremely emphasized. Alongside the stated factors, an increased competition is also present due to more prominent globalization, presence of a large number of low- priced competitors (generics, private labels, and low-priced clones imitating product leaders), competitors brand extensions, and widely noticeable deregulation. The answer to the challenges implies the following: maintaining the level of investments and innovation; getting closer to customers and focus on their loyalty; budget reallocations on more efficient and effective programs, taking into account the long-term brand equity and price integrity which may be jeop- ardized if the focus of the company in times of recession is on price reductions and discounts; adequate management and communication of financial, logistical, and psychological brand benefits compared to the competition (Keller, 2013, pp. 54-57). Implementation of effective marketing strategy should bring a strong market position and positioning in consumers minds to a company. High brand awareness and loyalty should result from this approach. In addition, higher market share is the result of these marketing activities. However, market share cannot be the only measure of success. Wong and Merrilees (2008, pp. 372–383) have established the link between brand performance and financial performance of a company. Also, Gromark and Melin (2011, pp. 394-410) have showed that 15% of the operating margin (EBITA) can be explained by the level of brand orientation of the company. EBITDA Margin and Operative Profit Margin are often used as measures of business success although they have certain disadvantages. EBITDA shows the results of business operations without expenses that can distort quality of business performances and implemented marketing strategy, but it is affected by significant number of other factors that limit its informativeness such as inventory assessments, short-term orientation, etc. (Alcalde et al., 2013, pp. 197-220). Helfert (2001, p. 104) argues that EBIT gives better view of operating effectiveness because it is not distorted by financing and tax effects.

3. OVERVIEW OF RESEARCH METHODOLOGY AND SAMPLE CHARACTERISTICS Although the level of internationalization is relatively high in ‘business to customer' oriented industries there are no significant empirical research about the effects of the internationalization on implementing marketing orientation in the suppliers business in Serbia and Montenegro and related modern marketing practices such as: brand management, integrated marketing communication, innovative product management, CRM, etc. For this reason, the authors have created a methodology and a concrete research on the importance of marketing for successful

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 business operations and its practical applications, depending on the company ownership origin and key brands origin. We have defined our main research questions as follows:  RQ1: Does consistent application of marketing lead to better financial results of a company?  RQ2: In the light of prominent internationalization and globalization of business, is there interdependence between company ownership origin and modern marketing concept implementation?  RQ3: To what extent can barriers to implementation of a modern understanding of brand be identified in domestic companies in comparison to foreign companies?  RQ4: Is there interdependence between brand origin and the level of implementation of marketing concept of doing business by the companies that produce/represent the brand?  RQ5: To what extent can barriers to implementation of a modern understanding of brand in business operations be identified depending on the brand’s origin (domestic vs. foreign)? From the above stated, the following hypotheses emerge:  H1: A higher level of application of modern marketing approach by the companies in Serbia and Montenegro leads to better financial results.  H2: The companies in Serbia and Montenegro with majority domestic ownership lag behind in the implementation of contemporary marketing practice when compared to foreign companies:  H2a: The companies with majority domestic ownership apply modern marketing approach in business to a smaller extent when compared to companies with majority foreign ownership.  H2b: More prominent barriers to implementation of modern brand management in business are observed in companies with majority domestic ownership.  H3: The companies which produce/represent domestic brands in Serbia and Montenegro lag behind in the implementation of contemporary marketing practice when compared to companies which produce/represent foreign brands in this region:  H3a: The companies which produce/represent domestic brands apply modern marketing approach in business to a smaller extent when compared to the companies which produce/represent foreign brands.  H3b: More prominent barriers to implementation of modern brand management in business are observed in the companies which produce/represent domestic brands in comparison to the companies which produce/represent foreign brands. In the theoretical part of the paper, the key characteristics of modern marketing approach in the conditions of intensifying of competition and strengthening of retailers’ position in marketing channels were emphasized. Pursuant to this, while constructing the scale for measuring the successfulness of marketing application in practice, the focus was set on product and brand, as the carriers of value for consumers, but also on treating marketing channels from the aspect of long-term relationships development, price as the reflection of brand value, and promotion as integrated means of communication with the target segments. Acknowledging the justifiableness of the critiques of classic approach to 4Ps of marketing mix (Constantinides, 2006, pp. 407-438), which it self favours transactional approach, the modern form of this concept was used. Attitudes favouring transactional approach heavily imbedded in a company, inability to recognize strategic aspects of branding, ignorance and misconceptions about the real effects and costs of branding, lack of information for decision- making and other reasons are a manifestation of brand myopia in its own right. Brand myopia can pose a barrier to company’s development and successful implementation of marketing in business practice (Gyrd-Jones et al., 2013, pp. 1056–1078; Ramaseshana et al., 2013, pp. 465–483; Burmann et al., 2009, pp. 264-284).

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 Having in mind the impact that particular factors have on company’s financial performance, 10 individual statements (variables) were singled out from a wider group of statements (variables) by means of t-test and correlation coefficient. These 10 statements constitute the latent variable Marketing Practice. Another 7 statements were also singled out, and they are a part of the latent variable Brand Myopia. The statements are set out in Table 1, and both scales have Cronbach’s alpha coefficient of over 0.7. While constructing the scales, the statements used in related researches were also partly taken as the starting point (Wong and Merrilees 2008, pp. 372–383; Kalicanin et al., 2015, pp. 155-173). A latent variable Customer-based Brand Equity (CBBE) was used as the manifestation of market brand position in the minds of final consumers. This variable was created based on the following aspects: consumers’ brand awareness, brand reputation and consumers’ brand loyalty. The shown mini-scale was inspired by the fact that de Chernatony in the research with his associates used precisely these three dimensions of CBBE (Christodoulides and de Chernatony, 2010, pp.43-66). Primarily the data on EBITDA Margin, as well as the data on Operating Profit Margin, were used as a measure of financial successfulness. As the source of financial measures of successfulness of business operations we used the following: 1) for Serbia, the data from the business portal of CUBE Risk Management Solutions, a specialized consulting company; 2) for Montene- gro, the data from the official financial reports from the Central Bank of Montenegro.

Table 1. Latent variables and description of constructs

Marketing Practice (Cronbach’s Alpha 0.756) 1. Branding flows through all of our marketing activities. 2. All key brands owned by the company have legal protection (they are registered at Intellectual Prop- erty Office) 3. Compared with competitors, we have a high rate of (product/service) innovation. 4. The perceived quality (assigned to the brand) increases customer loyalty which in turn increases sales revenues. 5. In comparison with the competitors, we have a high rate of technological advance. 6. Our brand has built a good reputation among retailers/distributors. 7. There is a great flow of information from our company to the retailers/distributors about the brand and the category in which we operate. 8. Brand value depends on the premium price that a product under the said brand can provide. 9. Our advertising/promotions create the desired brand image in the market. 10. We have graphic standards books for all the brands owned by the company. Brand Myopia (Cronbach’s Alpha 0.710) 1. Branding activities are too costly for us. 2. Branding is not needed until we grow a lot bigger. 3. In our company, there is no clear separation between the costs of product branding in comparison to other marketing costs. 4. In our company, brand building is dominantly seen as a cost, rather than an investment. 5. In our company, we do not invest enough in brand. 6. We monitor company performance on a regular basis. (inversly) 7. Brand management is a powerful instrument for improving the competitive position on the market. (inversly) Customer-based Brand Equity – CBBE (Cronbach’s Alpha 0.899) 1. Our firm has built a strong brand awareness in the target market. 2. Our company has built a good brand reputation among consumers. 3. Our firm has built a strong customer brand loyalty. 87

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 The research included managers and specialists in charge of planning and implementing brand and marketing strategies in companies, primarily CEOs, marketing managers, sales managers, and brand managers. The research was conducted during June and early July 2014. The respondents came from the companies that were doing business in Serbia and Montenegro at the time of the survey. Around 850 survey requests were sent by e-mail and addressed to companies’ representatives or managers in charge. A total of 145 responses was received. Each company could appear only once in the survey, regardless of the number of responses that came from it. Also, the research was specifically focused on manufacturers and representatives of B-to-C products. Upon eliminating the responses that were incomplete, invalid, doubled, and that came from the companies which primarily operated in the field of B-to-B products, our further analysis was based on 93 responses. The research of marketing practice, in the light of companies’ and brands’ origin, was a part of a wider research. Aside from the issues related to the topic presented in the paper, the goal was to collect managers’ opinions on different issues of modern brand and marketing management and business in general. A seven-point Likert scale was used in this particular research, and the respondents were requested to indicate the extent to which they agreed or dis- agreed with the presented statements. Out of 93 companies, almost 60% were producers. Small, medium-sized and large companies were relatively equally represented in the sample. Due to the size of the market, a large majority of companies in the sample were from Serbia (94.6%). Most companies in the sample were companies with majority or complete domestic ownership, while companies with foreign ownership made up somewhat over 1/3 of the companies in the sample. With respect to brands origin, the ratio of domestic (54.8%) and foreign (45.2%) brands is somewhat more balanced. Almost 80% of the companies were once exporters, although only 7.5% of the companies had the export which made over 50% of their sales. With respect to the type of goods which the key brand that companies produced/distributed belonged to, most companies operated in FMCG segment. The producers and representatives operating in the field of fresh and frozen food and packaged food were especially prominent, and together they made up 48.4% of the sample. The respondents’ characteristics are given below. There is a rather well-balanced number of responses by the respondents on following positions: Commercial Director (12.9%), CEO (11.8%), Marketing Director (20.4%), Marketing Manager (15.1%), and Brand Manager (15.1%). All other job positions make up 24.7% of respondents. The described structure reveals that the answers were provided by the individuals who participated in decision-making and implementing marketing strategies and programs in the companies. It is only logical that the stated positions required adequate education and qualifications. Pursuant to this, the respondents with Bachelor’s degree form 65.6% of the sample, while those with Master’s degree make up 23.7% of the sample. About two thirds of the respondents had education in the field of Economics and Business, and far less respondents (18.2%) had education in the field of Technical Sciences. As much as 83.9% of the respondents were in the interval of 30 to 49 years of age. The sex-structure of the sample was also relatively well-balanced, with somewhat larger number of male respondents.

4. RESEARCH RESULTS AND DISCUSSION

4.1 Exploratory analysis The presence of different categories of brands and companies in the sample, allowed us to implement the appropriate statistical and logical analysis. Correlation analysis was conducted in order to examine interdependence between the indicators of application of marketing in business operations and business results. It showed a statistically significant correlation (p<0.01) between the business performance measures and the two presented latent variables (see Table 2).

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 The strongest positive correlation, measured by Pearson’s coefficient, is between CBBE and Marketing Practice. In addition, the strongest negative correlation is between Brand Myopia and EBITDA Margin.

Table 2. Correlation between the indicators of application of marketing logic in business operations and business performance of the companies

Correlations Marketing Practice Brand Myopia EBITDA MARGIN* Pearson Correlation .478** -.396** Sig. (2-tailed) .000 .000 N 90 90 Operating Profit Margin* Pearson Correlation .401** -.369** Sig. (2-tailed) .000 .000 N 90 90 CBBE Pearson Correlation .608** -.327** Sig. (2-tailed) .000 .001 N 93 93 **. Correlation is significant at the 0.01 level (2-tailed).

* In three cases, the data about EBITDA Margin and Operating Profit Margin were not available. Source: The authors’ calculation

Taking into account the characteristics of brands, companies and respondents in the sample, we analysed whether there was a statistically significant difference regarding the achieved business results (EBITDA Margin and Operating Profit Margin). The limitation was the very size of the sample itself and so, due to this, in some cases the strata contained less than 30 subjects/responses. Statistically significant differences were determined only with respect to companies categorized by origin of ownership and their financial results, while in other cases no such differences were found at this level of analysis.

4.2 Impact of modern marketing approach to business on company’s financial results The starting hypothesis was set with the purpose to test if there was any kind of a link at all between adequate implementation of marketing in business and financial results. If there were no link, then the key reasons for successful business doing would have to be looked for else- where.  H1: A higher level of application of modern marketing approach by the companies in Serbia and Montenegro leads to better financial results. The variables Marketing Practice and Brand Myopia are used as indicators of modern marketing approach, whereby it is understood that the directions of their impact on financial indicators are different, and also that Marketing Practice has a positive impact while Brand Myopia has a negative impact. A multiple regression analysis was performed to explore if the independent variables (Mar- keting Practice and Brand Myopia) affected the dependant variable (EBITDA Margin). Therefore, 89

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 the objective was to determine whether Marketing Practice and Brand Myopia could explain the significant part of the variability of the EBITDA Margin as a dependant variable. In addition, the purpose of the performed regression analysis was also to determine which part of the variability of the dependant variable could be explained with independent variables. In this way, the strength of their bond was determined. In the structural element of the model, the regression parameters explaining EBITDA Margin indicated that both independent variables (Marketing Practice and Brand Myopia) had a significant influence on the dependent variable (p<0.1). Consistent with the starting assumption, the variable Marketing Practice had a positive, while the second independent variable (Brand Myo- pia) had a negative relationship with EBITDA Margin. The multiple regression accounted for 26.7% of the variability, as indexed by the R squared statistic (25.1% indexed by the adjusted R squared statistic). Model Summary is shown in Table 3.

Table 3. Relationship of Marketing Practice and Brand Myopia with EBITDA Margin – Model Summary

Model Summaryc Std. Change Statistics Error of Adjusted the R R Esti- squared F Sig. F Durbin-

Model R R squared squared mate Change Change df1 df2 Change Watson 1 .478a .228 .219 .08228 .228 26.011 1 88 .000 90 2 .517b .267 .251 .08062 .039 4.660 1 87 .034 1.944 95

a. Predictors: (Constant) Marketing Practice b. Predictors: (Constant) Marketing Practice, Brand Myopia c. Dependent Variable: EBITDA Margin Source: The authors’ calculation

The regression equation for predicting the EBITDA Margin is: ŷ= –0.054 + 0.039x1 – 0.020x2 x1 – Marketing Practice x2 – Brand Myopia The variable Marketing Practice showed the strongest relationship to EBITDA Margin. Brand Myopia was also an important factor of influence in determining of the chosen financial performance measure. The conducted multiple regression analysis confirmed that both independent variables affected EBITDA Margin as the dependent variable. Based on the findings that Marketing Practice as an independent variable had the most important influence on EBITDA Margin, it was used as the basis for segmentation of companies from the sample. The division to clusters was performed by means of Ward’s method of cluster analysis. The results are given in Table 4 and, even at first glance, they are pretty indicative. When observing the sample, we may say that the companies which had the highest level of marketing implementation in business operations (Cluster 2), and at the same time the lowest level of Brand Myopia, showed by far the best results. CBBE was significantly higher in comparison to Cluster 1 and Cluster 3, which means that the value of the brand in the consumers’ minds was at a far higher level. Financial indicators of company’s successfulness were also much better. Thus, Operating Profit Margin was almost twice bigger when compared to the companies from Cluster 1, while the companies from Cluster 3 (which had the weakest marketing implementation

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 in business operations) even had negative results when measured according to this parameter of company’s successfulness. When observing EBITDA Margin, we got similar results. Logically, the companies from Cluster 3, which lagged far behind in marketing implementation and had the most prominent Brand Myopia, showed the poorest results. The reason for concern is that this type of companies made up almost one quarter of the sample. All the stated differences, according to all the observed variables of successfulness of business operations and marketing practice implementation, were statistically significant at the level of p<0.01.

Table 4. The differences between the segments reported in the value of the latent variables, CBBE, Operating Profit Margin, and EBITDA Margin.

Operating Marketing Brand Profit EBITDA Ward’s Method Practice Myopia CBBE Margin* MARGIN* CLUSTER 1 Mean 5.14 3.22 5.49 4.53% 7.66% N 30 30 30 30 30 Std. Deviation .59393 .73470 1.11041 .0431845 .0639566 CLUSTER 2 Mean 5.92 2.04 6.21 9.58% 13.63% N 41 41 41 39 39 Std. Deviation .49131 .53825 .74804 .0749917 .0971179 CLUSTER 3 Mean 4.10 3.96 4.59 -2.65% 2.64% N 22 22 22 21 21 Std. Deviation .54685 .79353 1.46486 .1590253 .0777918 Total Mean 5.24 2.88 5.60 5.04% 9.08% N 93 93 93 90 90 Std. Deviation .89855 1.03655 1.23934 .1048706 .0931366

* In three cases, the data about EBITDA Margin and Operating Profit Margin were not available. Source: The authors’ calculation Based on the described statistical analysis we may conclude that H1 is proved, that is, that a higher level of implementation of modern marketing approach in business by the companies in Serbia and Montenegro leads to achieving better financial results. Proving H1 to be true is also the precondition for further analysis and proving other hypotheses regarding the connection between the companies’ and the brands’ origin and implementation of successful marketing practice in business operations.

4.3 The impact of origin of company ownership and brand origin on implementation of modern marketing approach to business As stated in the introductory parts of this paper, the markets of Serbia and Montenegro have experienced great changes in the past ten years. The key changes are related to the arri- val of a large number of new competitors, both global and regional brands, but they are also related to the acquisitions of the leading domestic producers and their brands made by foreign companies. Many world researches have tackled precisely this phenomenon, and it has been especially interesting to determine what happens on the markets of the developing countries, as well as what are the results of the ‘battle’ between domestic and foreign business concepts. In this sense, the authors wanted to investigate, in the light of prominent internationalization 91

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 and globalization of business operations, whether interdependence existed between origin of company ownership and implementation of modern marketing concept in Serbia and Montene- gro. In addition, it was necessary to also determine if there were differences in barriers to implementation of modern understanding of brand by domestic companies in comparison to foreign companies. For the above stated reasons, the second hypothesis is formulated as follows:  H2: The companies in Serbia and Montenegro with majority domestic ownership lag behind in the implementation of contemporary marketing practice when compared to foreign companies:  H2a: The companies with majority domestic ownership apply modern marketing approach in business to a smaller extent when compared to companies with majority foreign ownership.  H2b: More prominent barriers to implementation of modern brand management in business are observed in companies with majority domestic ownership.

Figure 1 clearly shows that there are differences with respect to the degree in which contemporary marketing practice is implemented in business, as well as what the barriers are, that is, how large Brand Myopia is in the companies with majority domestic ownership and in the companies with majority foreign ownership.

Figure 1. Differences in marketing approach depending on the origin of the company ownership

7.00

6.00 5.54 5.24 5.05 5.00

4.00 3.15 Marketing Practice 2.88 3.00 2.44 Brand Myopia

2.00

1.00 Foreign origin Domestic origin Total of company of company ownership ownership

Source: The authors’ calculation

Table 5 shows means of evaluations and of financial results for the chosen indicators. In order to determine whether the shown differences are statistically significant, a t-test was performed. The t-test confirmed that there were statistically significant differences in average values (arithmetic mean) of both variables, Marketing Practice and Brand Myopia, based on the origin of company ownership, with a statistical significance of p<0.01 level.

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 Statistically significant differences, at p<0.05 level, were determined for both EBITDA Margin and Operating Profit Margin. Only in the case of CBBE no statistically significant differences were shown, although this parameter showed better results for companies with foreign ownership. In this way both sub-hypotheses, H2a and H2b, were proved, whereby the hypothesis H2 was also proved in full.

Table 5. The summary of average values of variables depending on the origin of company ownership

Report Origin of Company Own- Operating ership (Foreign 0, Do- Marketing Brand Profit EBITDA mestic 1) Practice** Myopia** CBBE Margin* Margin* .00 Mean 5.54 2.44 5.70 12.02% 8.03% N 36 36 36 34 34 Std. Deviation .82194 1.10210 1.30433 .091802 .0746074 0 1.00 Mean 5.05 3.15 5.53 7.29% 3.23% N 57 57 57 56 56 Std. Deviation .89983 .89622 1.20323 .090120 .1165029 0 Total Mean 5.24 2.88 5.60 9.08% 5.04% N 93 93 93 90 90 Std. Deviation .89855 1.03655 1.23934 .093136 .1048706 6 ** Significance at p< .01 * Significance at p< .05

In three cases, the data about EBITDA Margin and Operating Profit Margin were not available. Source: The authors’ calculation

Since we determined that there were differences in the level of implementation and understanding of modern marketing, the next step was to determine if the interdependence existed between brand origin and the level of implementation of marketing concept in business operations of companies that produced/represented the brand. Also, in addition to the previous, the objective was to also determine was there a difference with respect to the barriers to implementation of modern brand management in business depending on the brand’s origin (domestic vs. foreign). The introductory parts of this paper explained the complexity of understanding of brand and its value depending on the brand being domestic or foreign, whereby foreign companies may own domestic brands and vice versa, domestic companies may own and/or manage foreign brands. From the above stated, the third hypothesis emerges.  H3: The companies which produce/represent domestic brands in Serbia and Montenegro lag behind in the implementation of contemporary marketing practice when compared to the companies which produce/represent foreign brands in this region:  H3a: The companies which produce/represent domestic brands apply modern marketing approach in business to a smaller extent when compared the companies which produce/represent foreign brands.

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100  H3b: More prominent barriers to implementation of modern brand management in business are observed in the companies which produce/represent domestic brands in comparison to the companies which produce/represent foreign brands. Table 6 shows average values of latent variables and financial results depending on whether the key brands of the companies from the sample were of domestic or foreign origin. By performing of t-test it was determined that a statistically significant difference existed at p<0.1 level and only for the Marketing Practice variable. Therefore, at this level of analysis, we cannot accept hypotheses H3a and H3b, and thereby also the hypothesis H3 cannot be accepted.

Table 6. The summary of average values of variables depending on the brand origin

Report Operating Origin of Brand (Foreign Marketing Brand Brand Profit EBITDA 0, Domestic 1) Practice Myopia Performance Margin Margin .00 Mean 5.43 2.79 5.75 8.86% 5.67% N 42 42 42 40 40 Std. Deviation .80154 1.06986 1.04113 .0879519 .0615286 1.00 Mean 5.08 2.94 5.47 9.26% 4.54% N 51 51 51 50 50 Std. Deviation .95129 1.01373 1.37924 .0979360 .1300179 Total Mean 5.24 2.88 5.60 9.08% 5.04% N 93 93 93 90 90 Std. Deviation .89855 1.03655 1.23934 .0931366 .1048706

In three cases, the data about EBITDA Margin and Operating Profit Margin were not available. Source: The authors’ calculation

It is obvious that there are factors which impact the fact that brand origin cannot be taken with certainty as the basis for making conclusions about the differences in implementation of modern marketing strategy, and even less that there is a noticeable difference in the shown results, both financial and market ones. The reasons for this are manifold, and in further text we will examine two possible ones: a) is the result shown for modern marketing practice implementation depending of brand origin impacted by brand ownership (whether the brand is owned by a company with majority domestic or foreign ownership); b) is the result shown for modern marketing practice implementation depending of brand origin impacted by whether the company is a producer or representative/distributor? In further text, the analysis of connection between brand ownership and company ownership will be presented. In the matrix of foreign and domestic company ownership and foreign and domestic brand, four possible alternatives have been determined. These alternatives are given in Figure 2, along with the number of companies belonging to the given stratum and financial indicators of successfulness of the companies’ business operations. The Stratum 3, constituted of companies with foreign ownership which own/manage a domestic brand, showed the best financial results that were highly evident. If we now focus the attention on how the companies in each stratum implement marketing and to what extent they point to the barriers to treating a brand, it can be observed that domestic companies which manage domestic brands lag behind the companies from the other strata in marketing implementation, but also that the order of companies with respect to successfulness of marketing

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 implementation is the same as the order of companies with respect to successfulness of company’s performance (Figure 3). In order to determine statistical significance of the stated differences, ANOVA analysis was performed. Statistically significant differences exist at the p<0.01 level for Brand Myopia variable, while they exist at the p<0.05 level for Marketing Practice, EBITDA Margin and Operating Profit Margin variables. These results must be taken with caution because some strata contain less than 30 companies. Nevertheless, one fact cannot be ignored and that is that domestic brands whose owners are foreign companies achieve the best results. The reason for this probably lies in the fact that foreign companies bought those companies and brands which were market leaders and they have given them new strength though their own standards and marketing principles of doing business.

Figure 2: The matrix of origin of company ownership and brand origin along with the financial business results COMPANY ORIGIN DOMESTIC FOREIGN Stratum 1 – Total: 38 companies Stratum 3 – Total: 13 companies 16.00% 16.00% 14.00% 14.00% 12.14% 12.00% DOMESTIC 12.00% 10.00% 10.00% 8.00% 6.78% 8.00% 16.30% 6.00% 6.00% 4.00% 4.00%

BRAND ORIGIN 1.87% 2.00% 2.00% 0.00% 0.00% EBITDA MARGIN Operating profit margin EBITDA MARGIN Operating profit margin Stratum 2 – Total: 19 companies Stratum 4 – Total: 23 companies 16.00% 16.00% 14.00% 14.00% 12.00% 12.00% FOREIGN 10.00% 9.37% 8.29% 10.00% 8.00% 8.00% 5.88% 5.48% 6.00% 6.00% 4.00% 4.00% 2.00% 2.00% 0.00% 0.00% EBITDA MARGIN Operating profit margin EBITDA MARGIN Operating profit margin

Source: The authors’ calculation

With respect to marketing implementation depending on the role that the companies in the sample had in marketing channels, it was possible to define three strata, regardless of the origin of ownership. These were the following: independent distributors, producers which produce in Serbia/Montenegro, and representatives and agents of foreign companies (dependent companies). Although the companies which were representatives (dependent companies) of re- nowned foreign producers showed the highest level of marketing implementation, this does not have a statistically significance when measured by ANOVA test.

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 Figure 3: Implementation of marketing philosophy depending on the type of company categorized by the origin of company ownership and brand origin Brand Myopia Marketing Practice

2.61 Strata 4 - Foreign company ownership and foreign brand origin 5.53

2.12 Strata 3 - Foreign company ownership and domestic brand origin 5.55

3.01 Strata 2 - Domestic company ownership and foreign brand origin 5.29

3.23 Strata 1 - Domestic company ownership and domestic brand origin 4.93

1.00 2.00 3.00 4.00 5.00 6.00 7.00 Source: The authors’ calculation

It would be interesting to explore the results of applying marketing logic in doing business and the financial results of the observed companies that were classified based on three stated dimensions: company ownership, brand origin and role in marketing channels. At this level of analysis and with this number of companies in each stratum, it is not possible to endeavour a more detailed analysis, but the first results are also indicative and they point to indifference of domestic comparing to foreign concepts. It is certain that this is an interesting topic and a possible direction of some future research that would be conducted on a larger sample.

5. MANAGERIAL IMPLICATIONS Although marketing practice is in its mature stage in the developed countries (it requires significant modifications and improvements), this research confirmed that implementation of marketing practice brings benefits to companies in the developing countries (Serbia and Mon- tenegro). Companies that implemented modern marketing practice had better market and financial performance. It is important to have a coherent marketing approach and to address the product, pricing, communication, and distribution elements in order to develop and position strong brands. International companies are better in marketing concept implementation compared to the domestic ones due to valid know-how and much more marketing experience. International companies bring valid know-how and enable local brands to have better performance. Likewise, foreign companies should also consider local brands as part of their marketing strategy because they enable companies to have better results. Our research indicates that glocal approach is applicable and desirable in developing countries, i.e. foreign ownership

Sasa Veljkovic, Zoran Bogetic, Dragan Stojkovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 79-100 of local brands. However, the sample size has not enabled the authors to statistically confirm this intriguing hypothesis. Elimination of local brands and introducing their global counterparts is not always the best solution. Local consumers are sometimes ethnocentrists. In addition, local brands may have a long tradition and be well positioned in consumers’ minds. This is their strength. However, local brands owned by local companies often lack adequate marketing support and this is the space for mutual cooperation and partnership. Marketing myopia is widely spread in both Serbia and Montenegro. This requires a continuous marketing education of managers of different levels. The classic and the modern marketing approaches should be presented to them. Managers must know that marketing approach evolves.

6. CONCLUSIONS, LIMITATIONS, AND FUTURE RESEARCH This research showed that implementation of modern marketing practice leads to more successful business operations and better financial results. It was also determined that, depending on the origin of (the majority) company ownership, there is a statistically significant difference in implementation of modern marketing approach. Foreign companies more consistently implemented modern marketing practice in business operations. With respect to differences in companies’ market approach depending on the origin of the key brands, no statistically significant differences were noted. There are some limitations of the conducted research, since the sample size did not enable us to get into several interesting aspects of the analysis:  It limited the findings concerning glocal approach, and this is a valid future research direction.  It did not allow us to perform analyses by different industries. It would be interesting and recommended for future research to focus on certain industries, such as pharmacy, food processing, etc.  Research by different positions in marketing channels (producer, distributor) was not possible, and this is also interesting subject for future research.  It limited the comparison of marketing practice implementation in Serbia and Montenegro.  It limited the analysis of marketing orientation at different managerial levels which would also be interesting to investigate. In addition, this research lacks the retail perspective, so future research would need to include retailers in order to get the complete marketing channels structure. In order to get valid results for the developing countries, research should se expanded to other countries as well. It would also be interesting to investigate and locate the bottlenecks for marketing implementation in companies at the strategic and tactical level.

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Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 101-111 ‘

Characteristics of the Economic Development of the Multi-Ethnic Regions of Russia

Svetlana Panikarova1, Maxim Vlasov2

1 Professor, Ural Federal University named after the first President of Russia B. N. Yeltsin, Ekaterinburg, Russia, E- mail: [email protected] 2 Docent, Ural Federal University named after the first President of Russia B. N. Yeltsin, Ekaterinburg, Russia, Senior Fellow at the Centre of Economic Theory Institute of Economics, Ural Branch of the Russian Academy of Sciences, Ekaterinburg, Russia, E-mail: [email protected]

ARTICLE INFO ABSTRACT Received May 27, 2015 Authors some features socially - economic development of multi- Received in revised from - ethnic regions of the Russian Federation presented in article. Based Accepted October 16, 2015 on the analysis of regional statistics data authors showed that mul- Available online 30 Dec. 2015 tiethnic regions lag behind the average Russian level on the main socio-economic indexes. Results of research also proved that tradi- JEL classification: tional and agricultural types of economic activity prevail in these R11, R58 regions for the reason that endogenous and exogenous factors work. The author's statement about unacceptability of application of DOI: industrial methods of regional economic development to multiethnic 10.14254/1800-5845.2015/11-2/6 regions is proved.

Keywords: Economic development, Multi-ethnic regions, Competitiveness differentiation of regional development

1. INTRODUCTION The high level of inter-regional differentiation in all key economic and social characteristics, which is so distinctive of Russia, is largely due to natural differences, the geographical evolution of the Russian state, the stage of economic development of the country and the outcomes of the preceding period. The socio-economic differentiation of regions manifests itself as differences in the quality of life, determined by the competitiveness of the regional economy (internal factor) as well as transfers from other regions and the central state (external factor). The question of increases or decreases in the heterogeneity (or differentiation) of the socio-economic space of Russia is of great importance since it has a significant impact on the evolution of economic institutions, structure and efficiency as well as the strategy and tactics of social and economic policy. In recent years, differences in the socio-economic situation of the regions have increased across almost all statistical indicators.

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Svetlana Panikarova, Maxim Vlasov / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 101-111 Researchers distinguish between economic and social inequality while emphasising the close relationship that exists between them (Zubarevich, 2008). A certain degree of differentiation of the economic space of a region is natural and even beneficial. It carries a certain “dynamism” into the economy, creating a necessary tension. The primary cause of economic differentiation is the process by which economic activities are concentrated in areas that offer advantages that allow businesses based there to reduce their costs. Among these advantages P. Krugman highlighted factors of a “first nature” (wealth of natural resources, advantageous geographical location) and factors of a “second nature” (agglomeration effect, high human capital, better institutional environment), which are related to the activities of the company (Krugman. 1991). While the Russian economy is oriented towards geographical factors of the “first nature”, the economic inequality of regions will continue to grow. According to N. V. Zubarevich, there are three kinds of advantage obtainable in contemporary Russia: the agglomeration effect (economies of scale), the availability of mineral resources demanded by the world market, and, to a lesser extent, a prime location on the main global trade routes, predominantly coastal. These advantages manifest themselves in superior growth accruing to the territories: the largest agglomerations of federal cities, the oil and gas and met- allurgical regions and the southern and western coastal regions. As a consequence, economic inequality between regions is growing (Zubarevich, 2008). The situation is reversed when it comes to the differentiation of social space, in particular, the quality of life of the population. Here any deviation from socially acceptable standards is not only contrary to the fundamental law of development of human society but also fraught with serious consequences for the economy. Injustice and inequality lead to incomplete use of human potential; elimination of accumulated social imbalances in the future will require not only high material costs but also of time; such disparities can lead to social explosions (Kuznetsova, 2009). The persistence of these trends would entail the actual differentiation of the social and economic rights of citizens, irrespective of their place of residence, possibly leading to mass migration from depressed regions and the emergence of ethnic conflicts, including the manifestation of various forms of intolerance, nationalism and xenophobia. There are more than 100 ethnic groups in the Russian Federation. The number of members of Russian indigenous ethnic group is about 19.7 million, and from them 9.5 million indigenous people live in rural areas. In Russia territories are accommodated by indigenous people have the status or the republics, or autonomous region, national territories or without any special status. The current socioeconomic circumstances of the Indigenous people in Russia are poor. For example, according to the 2010 census (compared with the 2002 census), in 19 out of the 26 indigenous regions, the socioeconomic situation of the indigenous population is showing a numerical decline. The aim of the present paper is to find out peculiar characteristics of the economic development of the multi-ethnic regions of Russia that are predetermined by social – economic and political changes at different stages of development of the country.

2. METHODOLOGY The article takes an eclectic methodological approach to piece together extant literature and to discover new empirical knowledge about socioeconomic circumstances of the Russian multi-ethnic regions. The data source of our research is data of Rosstat (Federal State Statistics Serves) and data of Expert RA (International group of rating agencies). Such indicators as GRP, Unemployment Rate, Subsistence Level, Poverty Rate were taken from a database of Rosstat. In Russia, GRP is measured in basic prices, i.e. net of taxes including subsidies on products. GRP is determined by using the production approach, i.e. as a difference between the re-

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Svetlana Panikarova, Maxim Vlasov / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 101-111 gion’s gross output and intermediate consumption, or as a sum total of all the values added by all the economic activities in the region. Rosstat considered unemployment as defined by OPNZ using the criteria of the Interna- tional Labor Organization (ILO). According to ILO, an unemployed person is one above the age of 15 without revenue, who is able to work and actively searching for job. Regional subsistence level are calculated on the basis of consumer baskets and Rosstat price data. The region’s consumer basket is set by its legislature on the basis of federal methodological recommendations with regard to local natural, climatic, social and demographic specifics. To compute the poverty rate, Rosstat draws on the subsistence rate determined by the regional authorities on the basis of the nation-wide consumer baskets for working age population, pensioners and children. Such indicator as Investment Climate Rate was taken from a database of Expert RA. In terms of the components of the investment climate, two relatively independent characteristics are used: investment potential and investment risk. The evaluation of the investment climate of regions generally consists of the following steps: 1) calculation of the proportion of each region in Russia in terms of 9 types of investment potential and indexes of 7 types of private investment risk; 2) all regions ranked by size of total investment potential or integral investment risk; 3) to each region is assigned a rating of investment attractiveness, with the index defining the ratio between the cumulative level of investment risk and the amount of total investment potential of the region. Each region of Russia belongs to one of 12 rating categories according to the ratio of the value of the aggregate potential and integral risk: 1A – High potential / minimum risk; 1B – High potential / moderate risk; 1C – High potential / high risk; 2A – Average potential / minimal risk; 2B – Average potential / moderate risk; 2C – Average potential / high risk; 3A – Low potential / minimal risk; 3B1 – Low potential / moderate risk; 3C1 – Reduced potential / high risk; 3B2 – Slight potential / moderate risk; 3C2 – Slight potential / high risk; 3D – Low potential / extreme risk.

3. RESULTS AND DISCUSSION The multi-ethnic regions, in the system of regional organisation of the Russian economy, are highly heterogeneous. Statistical analysis permits the basic parameters of social and economic development to be differentiated and demographic and resource potentials to be expressed. Out of all geographic regions in the multi-ethnic groupings, it is undoubtedly the case that to the economically backward and high-problem areas pertain two in particular: the Caucasus and South-Siberian Republics. In Fig. 1 it can be seen that all these regions have a per capita GRP significantly below the Russian average. While in other multi-ethnic regions (except the autonomous regions of Sakha, Komi and Tatarstan), GRP per capita is lower than average for the Russian Federation, in the Republic of the Caucasus and South Siberia it is significantly lower in terms of manufacturing output. At the same time, almost all regions of the Caucasian and South Siberian Republics (with the exception of Ingushetia, Chechnya and Tuva) are characterised by high levels of per capita agricultural production (Fig. 2). The multi-ethnic regions can be divided into three groups according to the volume of extractive industries per capita: 1) regions in which the volume of extractive industries per capita of population comprises 600,000 rub. and above (Yamalo-Nenets, Khanty-Mansi, Nenets and Chukotka Autonomous Districts and the Sakha and Komi Republics; 2) regions in which the volume of extractive industries is compared with average Russian indices (67,900 rub. in 2013)

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Svetlana Panikarova, Maxim Vlasov / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 101-111 and from 40,000 rub. to 150,000 rub. (Karelia, Bashkortostan, Tatarstan, Udmurtia, Khakassia and Orenburg oblast); 3) regions in which the volume of extractive industry output is insignificant (less than 40,000 rub. per capita).

Fig. 1 GRP per capita, thous. rub., in the multi-ethnic regions of the RF (2013)

South-Siberian Republics

Caucasus Republics

Russian average

Source: research of the author

Fig. 2. Manufacturing and agricultural production per capita in multi-ethnic regions, thous. rub. (2013)

Source: research of the author

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In general, these groups of regions consist of economically backward areas. This is reflected in the income levels of the population. In Russia, the income level of the population must be measured with an adjustment to the regional minimum subsistence level, since prices across the regions can vary more than three-fold. The highest per capita income among the multi-ethnic regions is in the raw materials autonomous districts (Yamal-Nenets AD, Nenets AD, Khanty-Mansi AD, Chukotka AD) (on average four times higher than the subsistence minimum). In the group with incomes above the average, in addition to the raw materials regions, are the three Republics – Tatarstan, Bashkortostan and Dagestan (Fig. 3). For Tatarstan it is in part a consequence of the artificially low level of subsistence due to the long-term subsidies applied to basic foodstuffs and socially important services. Dagestan has the highest rate of income growth of the population in 2002-2013, outrunning incoming purchasing power (ratio of per capita money income to the subsistence level in the region) not only compared with other North Caucasus Republics, but also other Russian regions. The purchasing power of the population for the years 2002-2013 increased in Dagestan by 3.2 times (while the average increase for Russia overall was 1.7 times). Notwithstanding, it should be noted that in most of the North Caucasian Republics, the pace of income growth was higher than in the others. Keeping pace with Dagestan, incomes were also growing in Ingushetia (3.2 times) and North Ossetia (2 times). This can be explained by non-economic factors, primarily in terms of Federal government policy. The remaining Republics are divided into groups with middle and low income; moreover, this distribution is not always linked to the level of economic development. Statistics show that incomes were lowest in the Republics of Tuva and Kalmykia both in terms of their level and dynamics. Very slow income growth characterised the Republics of Karelia, Sakha and Komi, while falling purchasing power occurred in the Khanty-Mansi and Yamalo-Nenets Autonomous Districts (Fig. 3). There is no common trend (lead or lag) for the Republics.

Fig. 3. Ratio of per capita incomes to subsistence level in the region, %

Source: research of the author

Of course, one should take into account the low accuracy of the measurement of standards of living in Russia, particularly in the Southern Republics, where the most significant proportion of shadow incomes are experienced. The "grey", "non-observed" economy is especially characteristic of those subjects of the Russian Federation that are considered to be the poorest regions. 105

Svetlana Panikarova, Maxim Vlasov / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 101-111 The labour market is closely linked with the economic status of the region as well as with demographic factors. As a consequence, the problem of unemployment in the underdeveloped Republics showing a positive demographic trend is more acute than in the "Russian" regions. The Republics of the North Caucasus and South Siberia are especially highlighted in this respect. Every year, the labour markets in these regions receive a large influx of young working- age population, for which there are not enough new jobs as a consequence of the underdevel- opment of the economy. In the North Caucasus, unemployment is somewhat mitigated by territorial mobility; nevertheless, the extent of labour migration is insufficient to relieve tension on the labour market. As a consequence, in these Republics, unemployment is maintained at a sufficiently high level (Fig. 4). A third of the Republics are among the problem areas (having unemployment rates above 15%); however, the data for Ingushetia, where unemployment affects around half of the economically active population, raises serious questions. A large proportion of the population is employed in the informal economy, which is not reflected in an employment status according to the labour market surveys. In the medium- to more-developed Republics, the problems of the labour market are little different from the overall Russian pic- ture, with the exception of the northern resource-producing Komi Republic, where unemployment has increased due to the limited supply of jobs in non-diversified towns and extractive industry villages. Similar problems in terms of the labour market are experienced by the Sibe- rian Republic of Buryatia.

Fig. 4. Unemployment rate, %

Source: research of the author

Varying significantly across the multi-ethnic regions is one of the most important social indicators – poverty. The better-developed Republics (such as Bashkortostan and Tatarstan) have low poverty rates (Fig. 5). This is a result of sustained economic growth and wage increases that

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Svetlana Panikarova, Maxim Vlasov / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 101-111 have lifted most working families out of poverty. The least developed Republics, with the excep- tions of Tuva and Kalmykia, have rapidly reduced poverty through federal aid programmes. However, a comparison of the average poverty levels in Russia overall with those in the multi- ethnic regions shows that the latter differ markedly for the worse.

Fig. 5. Number of people with incomes below the subsistence level as a percentage of the total population

Source: research of the author

In some Republics, the poverty level decreased dramatically in the 6 years from 2005 to 2013; for example, in Ingushetia, where it dropped from 63.2% to 17.9%. Is it possible to discount all the bad statistics and assume that this is the result of an artificial understatement of the figure? Or has one single Republic been able to do what has not worked in all the other problem regions and bring all the most important social indicators up to a reasonable level? Moreover, the sharp improvement in income and poverty in Ingushetia has seemingly taken place against the backdrop of minimal progress in reducing unemployment. The real reason lies in the sharp increase in federal aid to Ingushetia over the last two or three years, resulting in a significant increase in social benefits paid to poor people (families with many children, and others). Therefore, the phenomenon of the success of the Republic has a non-economic basis: it is a consequence of the special support of the federal government. The standard instrument for comparing the general standard of living in different countries and regions is the Human Development Index (HDI). This is an aggregated indicator, which is calculated annually to measure standard of living, literacy, education and longevity as the primary characteristics of the human potential of the studied territory. When calculating the HDI, three types of indicators are taken into account: life expectancy; the average number of years spent on education and school; life expectancy; standard of living, calculated by GDP per capita at purchasing power parity. Unfortunately, HDI is shown in most multiethnic regions to be below the national average (excluding, as has been repeatedly said, Tatarstan) (Fig. 6). The reason for the low HDI in the South Siberian Republics, besides the low standard of living, is the low life expectancy and mediocre level of education.

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Svetlana Panikarova, Maxim Vlasov / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 101-111 The locations of investment are the best indicator of development priorities (Table. 1). The highest levels of investment are received by the raw materials (especially oil and gas) producing regions. Tatarstan is among the relative leaders due to a combination of the two sources of investment – business (in oil production and other sectors) and Federal investments. These investments show precisely to what extent the underdeveloped Republics are unattractive to business, lagging behind the average by 2-5 times.

Fig. 6. The Human Development Index of the multiethnic regions of the RF

Source: research of the author

Table 1. Per capita investment in fixed assets,% of the Russian national average (national average = 100)

Federal Subject 2002 2007 2013 Federal Subject 2002 2007 2013 1 2 3 4 5 6 7 8 Karelia 105.5 58.6 51.1 Mordovia 68.9 68.7 71.3 Komi 177.8 137.3 200.8 Tatarstan 123.7 120.7 147.1 Nenets AO 2825.9 4595.8 1517.5 Udmurt Republic 60.1 61.4 51.2 Republic of 35.4 52.6 38.8 Chuvash Republic 51.4 62.7 51.6 Adygea Republic of 129.7 45.4 56.1 Orenburg Oblast 68.3 81.1 82.1 Kalmykia Astrakhan Oblast 109.1 106.0 123.2 Ulyanovsk Oblast 36.3 56.2 64.9 Republic of 25.6 48.1 65.3 Khanty-Mansi AO 910.1 539.1 490.1 Dagestan Republic of Ingushetia 12.5 32.7 31.8 Yamalo-Nenets AO 2126.6 1127.0 1166.8

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Kabardino- 42.8 30.4 28.1 Chelyabinsk Oblast 76.3 78.8 65.5 Balkaria Karachay- 41.3 44.9 43.2 Altai Republic 52.4 61.2 60.3 Cherkessia North Republic of 33.6 44.1 41.1 54.0 42.9 44.1 Ossetia Buryatia Chechen Republic 36.8 73.1 33.4 Republic of Tuva 17.6 16.3 44 Stavropol Krai Republic of 58.9 42.0 48.2 41.4 68.6 61.8 Khakassia Bashkortostan 94.4 83.7 70.9 Sakha 224.9 266.7 219.7 Mari El Republic 33.2 51.6 70.8 Chukotka AO 762.6 235.0 222.6

Source: research of the author

The problem of low investment is either due to political or institutional risk (North Caucasus Republics) or to a very strong rise in the cost of economic activity due to remoteness and poor infrastructure (Republics of South Siberia). Ratings for the investment climate of the multi-ethnic regions remain low. According to the evaluation by Expert RA, stable ratings in Tatarstan and Bashkortostan; in recent years, ratings have increased in the Khanty-Mansi Autonomous District and the Chelyabinsk Region (Table. 2). The South Siberian Republics either demonstrate a negligible / low potential – moderate risk (3B1/2) like Buryatia and Khakassia, slight potential – high risk (3C2) like Altai, or low potential – extreme risk (3D), like Tuva.

Table 2. Ratings for the investment climate of the multiethnic regions (according to figures from Expert RA).

Region 2002 2007 2013 Region 2002 2007 2013 1 2 3 4 5 6 7 8 Republic of Sakha Astrakhan Oblast 3В1 3В2 3B1 2С 2В 3B1 (Yakutia) Kabardino-Balkaria 3В2 3С2 3C2 North Ossetia-Alania 3В2 3С2 3C2 Karachay-Cherkessia 3С2 3С2 3C2 Republic of Tatarstan 2В 2В 1A Nenets AO 3В2 3С2 3B2 Republic of Tuva 3С2 3D 3D Orenburg Oblast 3В1 3В1 3B1 Republic of Khakassia 3В2 3В2 3B2 Republic of Adygea 3В2 3С2 3B2 Stavropol Krai 3В1 3В1 3B1 Altai Republic 3В2 3В2 3C2 Tyumen Oblast 3В1 3В1 3B1 Bashkortostan 2В 2В 2B Udmurtia 3В1 3В1 3B1 Republic of Buryatia 3В1 3В2 3B1 Ulyanovsk Oblast 3В1 3В1 3B1 Republic of Dagestan 3С1 3С1 3C1 Khanty-Mansi AO 1С 2В 2B Republic of Ingushetia 3D 3D 3D Chelyabinsk Oblast 2С 2В 2B Kalmykia 3С2 3D 3C2 Chechnya 3D 3D 3D Karelia 3В2 3В2 3B1 Chuvashia 3В1 3В2 3B1 Komi Republic 3С1 3В1 3B1 Chukotka AO 3С2 3С2 3C2 Mari El 3В2 3В2 3B2 Yamalo-Nenets AO 2С 2В 3B1 Mordovia 3В2 3В2 3B2

Source: research of the author

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Svetlana Panikarova, Maxim Vlasov / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 101-111 4. CONCLUSIONS Thus, the conducted analysis leads to the following conclusions:  The multiethnic regions form several geographically isolated groups. A low level of socio- economic development distinguishes the Volga-Vyatka region as well as the South Sibe- rian and Caucasian Republics. These geographical groups do not have either the industrial capacity (as in the Ural-Volga region) or the natural-resource potential (both North and West Siberia).  For the majority of the underdeveloped Republics it is characteristic that, while per capita GDP, manufacturing volume and extractive industrial output are well below the national average, agricultural output tends to be above the national average.  In the underdeveloped multiethnic regions there is a worse labour market situation and more poverty than average for Russia as a whole; however, earnings growth rates vary, as does poverty reduction, with these being more dependent on non-economic factors (such as the federal policy).  Unfortunately, HDI is shown in most multiethnic regions to be below the national average (excluding Tatarstan). The reason for the low HDI – besides the poor standard of living – is the low life expectancy and mediocre level of education.  The highest levels of investment are received by the raw materials (especially oil and gas) producing regions and Tatarstan. The problem of low investment is either due to political or institutional risk (North Caucasus Republics) or to a very strong rise in the cost of economic activity due to remoteness and poor infrastructure (Republic of South Siberia). To conclude, the multiethnic regions of the Russian Federation are generally lagging behind in terms of their socio-economic development. Development trends in the economic space of the Russian Federation suggest that this gap will only increase in the future. We can adduce the reason for this as being the heterogeneity of the economic space, in which a process of concentration of economic activity takes place in areas that already have a competitive advantage. In this connection, it is necessary to study the economic and social spaces of the regions from the perspective of a possible increase of competitiveness, i.e. the creation and development of competitive advantages.

Acknowledgment The study was financially supported by the Russian Science Foundation, project No. 15-18- 00049

REFERENCES Bortnik, V. M., Zinov, V.G., Kotzubinsky, V.A., Sorokina, A.V. (2013), “Indicators of economic development of the Russian regions for monitoring and management” Innovations, No. 11. 2- 13. Krugman P.R. (1991), Geography and Trade. Cambridge. MIT Press, MA:. Kuznetsova O.V. (2002), The Economic Development of Regions: Theoretical and Practical As- pects of State Regulation, Pub.5, Editorial URSS Publ., Moscow. National Human Development Report 2013 for the Russian Federation (2013), LLC RS Ilf. Panikarova, S. (2014). “Evolution of traditional economic institutions for Aboriginal Nations”, Conference Proceedings: 8th International Days of Statistics and Economics, 1094-1105. Panikarova, S. (2015), “Status of the indigenous regions in Russia: The case of Khakas people”, Asia-Pacific Social Science Review, Vol. 15, No. 1, 141-148 Pilyasov, A.N. (2009), The last will be the first. Northern periphery on the road to knowledge based economy. Book House “Libricom”, Moskow.

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State Statistics Committee (Goskomstat), “Regions of Russia. Socio-economic indexes. 2012”. URL:http://www.gks.ru/wps/wcm/connect/rosstat_main/rosstat/ru/statistics/publications /catalog/doc_1138623506156 Zubarevich, N.F. (2008), “Socio-Economic Development: Myths and Realities of Balancing”, SPERO, No. 9. 7-22.

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Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124

Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 113-124 ‘

Implications of Institutional Dispositions of Neoliberalism

Slobodan Lakic1, Mimo Draskovic 2

1 Associate Professor, Faculty of Economics, University of Montenegro, Podgorica, e-mail:[email protected] 2 Assistant Professor, Maritime Faculty of Kotor, University of Montenegro, Kotor, e-mail: [email protected]

ARTICLE INFO ABSTRACT Received May 27, 2015 This analysis starts with an assumption that vertical paradigm of Received in revised from Oct. 27, 2015 neoliberalism positions the state regulation only as a formal Accepted December 01, 2015 center of power, and that non-state institutions (mainly banks) Available online Dec. 03, 2015 acquire de facto economic and political leverage over the state. Here is a definitive break with the liberal horizontal paradigm JEL classification: (order). State institutions coordinate the vertical system and E42; E52 mediate between the individual institutional pillars. Standard of price setting is determined by oligopolistic and monopolistic DOI: prices. In this document, we test the hypothesis in the case of dominating the instruments of the “market“ institutions in rela- 10.14254/1800-5845.2015/11-2/7 tion to the regulatory instruments and inefficiently modeled financial markets over the entire financial system, i.e. privileged Keywords: institutions over the state authority. Specifically, we prove the Neoliberalism, domination of the market interest rates over the official interest Banks, rates, modification of the protective and destructive corporate Interest rates, pattern “too big to fail“, as well as aggressive manipulating the Monetary policy, selective scope of derivative and high frequency trading. Derivatives, High frequency trading

1. APPROACHING THE ISSUE OF INTERVENTIONAL CONTROVERSY

The concept of unconditional government intervention that assumes rescuing private entrepreneurs, whereby the public bears the cost, is known as Keynesianism. The modern state has created institutions that enable improvements in production and distribution, but also the incen- tives to coincide the interests of society with the interests of entrepreneurs, who are the founders and take initiatives. Relative importance of corporations has dramatically increased in relation to the state because multinational investments grew several times faster than the economic growth. Corporate sector with the rule of oligopoly has enthroned as the dominant sector of the economy. The concentration has led: to the creation of monopolies and oligopolies, and eliminating the competition; and controlling the industry through vertical integration (Lakic, 2012, p. 288). Men- tioned economic-political constellation is explicitly expedient to analyze in a monetary, banking and credit system of the most developed financial economies (US, UK, Japan).

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Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 Given that the Federal Reserves (Fed), formally dominant global financial institution, over the last decade have held short-term interest rates at record low levels, Wall Street got the impetus to create the risky loanable products (e.g., subprime or interest). Using cheap money (essentially for free) the Fed have favored the large banks (big players) in the Wall Street, which manipulated the markets and de facto controlled the central bank. By “bailing-out“ the banks, the Fed were supposed to put themselves in danger and exposed to the collapse, in the conditions of factual insolvency (on the market-to-market basis) and the enormous leverage (debt). During the recent financial crisis, the Fed “secretly“ conducted so far unprecedented intervention, worth more than an annual US GDP. The price of the arrangement is several times lower than the interbank borrowings. The implications of such operations are: − interventions based on (artificially) low interest rates over a longer period have not been carried out in order to stimulate demand, − interventions have a negative impact on the market volatility and the economy in general, and − interventions create monetary framework with rapid decrease of the money multiplier (which is difficult to prevent) and reaching levels from 1929. Restrictive or expansive direction of monetary policy, in the context of causes of world financial crises, has been the subject of numerous theoretical and empirical research (modeling) at the level of monetary macroeconomics and/or financial econometrics. Contrary to M. Fried- man and Schwartz (1991) and others during the nineties, O. Blanchard (2003) has suggested that the Fed was not directly responsible for the contraction of nominal money supply (money multiplier decrease) during the period 1929-1933. The real money stock was almost constant. The consequences included the ultimate decline of nominal interest rates and the high rate of deflation  a proportional decrease in the price level. Recall, the bank lending wes dominant for the purpose of financing speculative activities, but interventions of the central bank managed merely to “temporarily stimulate the economy“. According to A. Schwartz, on the eve of the current crisis, monetary policy in the United States was expansive, while analysis, such as D. Henderson’s and J. Hummel’s (2008), show that A. Greenspan’s policy was “imperfect”, but with restrictive direction. The development paradigm with particular criteria and values has existed in all historical periods of the society. Development has always had a contradictory character, because order and chaos have never existed in a pure form, but in different combination. The dominance level of order or chaos in society was determined by the extent of the crisis in general and in specific areas, and consequently by the rate of development (Draskovic, 2014, p. 5). But through the lens of phenomenology and ontology, there is nothing unusual, because the order of the above formulas is maintained by the same methodology by which it was created: paradoxes, promises, opportunistic behavior, interests of big capital, and power ambitions.

2. TRANSMISSION OF POWER AND CONTROL IN NEOLIBERAL HIERARCHY A lot has been written about the causes of the global economic crisis, applying the various aspects: mythical, realistic, perspective, causal, consequential, structural, cyclical, programmed and other. Objective researchers should note the connection, as well as the specific synergy of global and local influence factors. There is one common denominator, and that is the lack of regulation at all levels, from the national and down, or generally deficit of institutional development, institutional competition and institutional discipline. In the era of knowledge, globalization, virtualization, decentralization and informatization, the only realistic and efficient connec- tive tissue should be institutional subordination of economic entities at all levels. In other words, institutional pluralism should be a prerequisite for all other economic activities, measures, plans and results. Why is there institutional deficits at all levels, due to which the contemporary global economic crisis has provoked strong reaction of the state?

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Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 Krugman (2009, p. 38) writes about the blindness of the economics profession, which has not predicted very strong possibility of catastrophic failures in a market economy, because of the illusion of rational individuals and their interactions on the perfect markets. Many other economists have warned that the dominant neoliberal concept of economic policy and unwar- ranted enormous wealth are unsustainable, and that financial markets are very unstable (N. Chomsky, A. Kobjakov, M. Hazin, S. Rich, J. Stiglitz, J. Gray, G. Soros, M. Rabin, D. Harvey et al.). The limitations of human rationality and imperfections of the market have been ignored, as well as the possibility of quasi-institutional and opportunistic behaviors that are manifested through various forms of virtual and speculative business, greed, weakness of institutions, government and business ties, ideologized economic theory and its apologetics, deficit of the moral, legal, environmental and other social restrictions (Draskovic, 2009, p. 129). One of the basic contradictions of neoliberal economic policy is that it has enabled paradoxical gap between the privileged power of the elite and limited institutional power of the state. An- other contradiction has directly resulted from the first: an elitist urge for quick creation and increase of the wealth, dominance and total power have substituted institutional control. In such circumstances, institutional vacuum (created intentionally, due to the neoliberal conception of institutional redundancy), has reproduced the power of networking and informal groups (Draskovic, 2014). Contradictional context of neoliberal economic policy has its doctrinal termi- nology, monistic-institutional, anti-developmental, cognitive, strategic, interest, redistributive, ownership, civilizational, geopolitical and ideological sense, but also a number of crisis quasi- manifestations in practice. The mentioned economic policy, in global and local boundaries, has appeared as immoral, inhumane, brutal, chaotic, crisis and hegemonic system of the power, domination, violence, exploitation, and greed. All this have resulted in neoliberal monopolization.

Figure 1. Modification: from liberal to neoliberal paradigm

Regulator (state)

Informal power centers (the neoliberal paradox):

large financial institutions become a key segment of Financial and non- the market, squeezing out smaller institutions and financial institutions causing counteparts Power tration concen-

Market standard: oligopolistic and Market (financial and monopolistic prices

non-financial) Product of the crisis: reduction of the market ant its laws  Real economy

Legend: liberal paradigm; neoliberal paradigm

Source: Author’s creation

Important for our presentation is the way that has led to a rearrangement of institutional recomposition of competence and actual decision making, which essentially meant the modification from liberal to neoliberal paradigm (Figure 1). The modern theory of corporatism does not 115

Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 recognize historical rise of corporatism, from the initial dominant influence of the state, and then its gradual weakening, and finaly the enthronement of corporation. It has constructed a model, through which the state and large corporations have formally imposed a comprehensive system of regulating the societal relations, a privileged relationship of individual corporations within the sector, and then the system of “agreement and arrangement“ between the countries  corporations, system for redistributing the profits among the selected participants, unlimited financial and logistical support of state institutions during hardships. Introducing the theory of imperfect competition, in the thirties and forties, oligopoly and limited (imperfect) competition among several large sellers are increasingly seen as an important and significant limitation of the free play of market forces and mechanistic marginalism. Model (theory) of power in setting prices is increasingly represented in the literature, empirical research of monopolistic conditions in many economy sectors. We conclude that large corporations have definitely broke up with the old joint stock-capitalist relations. Real managers of large corporations are interested in a part of the social product, instead of the amount of paid dividends. Multinational corporations have become the new nation-states, while the old nation- states, being less powerful, began to follow the orders of the market (Lakic, 2012, p. 292). The risk is multiplied by prevailing speculative and arbitrage strategies in relation to the hedging investment strategy. Aggressive strategies based on the prompt and/or net buying and selling are taken over by the gigantic financial conglomerates. Institution size, measured by assets or deposits, by total revenues and their comparison, by value added as a net income and, in particular, by off-balance items, becomes the basis of domination and thereby abuse, which usually does not lead to an adequate regulatory or regulative response. The dominance of the institutions over the state regulation is manifested in: dominance of price of instruments of dominant market institutions; change of legislation in favor of favored institutions, at the expense of state authority. Central banks as cartels of private banks (Fed case) take on the mechanism for implementing economic policy. Thus, the supreme monetary authority legally and factually takes over the powers of government (state), but is in the process of policy implementation stays in a subordinate position in relation to commercial, investment and universal banks and, indirectly, their extended entities such as hedge funds, SPV or SPE. These institutions are becoming informal center (concentration) of power. The interbank markets (wholesale markets) become the center of the world market in terms of inputs and consequences, determining not only the quantity but especially price indicators (interest rates, exchange rates) and speed of trading.

3. MANIPULATING THE INTEREST RATES: RELEVANCE OF THE MARKET INTEREST RATES Due to the financial crisis, the collapse of financial markets complicates the problem of asymmetric information and prevents the efficient allocation of resources in accordance to the most productive investment opportunities, resulting in a remarkable decline in economic activity. The theory of financial crisis on asymmetric information, in terms of cause and implications, has found a practical field for analysis in the current financial crisis. According to the theory, restrictive monetary policy has fueled the crisis through the following factors: the rise in interest rates, stock downs, non-anticipated decline in price levels, increasing uncertainty and banking panics. However, the fact is that the accumulated and deferred implications are tens of trillions of dollars of debt on the balance sheet of the banking system, whose growth is doubled compared to the rate of economic growth. For example, for every dollar of economic growth, the banking system creates US $30 credit. Restrictive monetary policy in the context of an extreme case of increased problems effectuates the following mechanism (“extreme case of asymmetric information“)  Figure 2.

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Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 Figure 2. Effects of restrictive monetary policy in the context of crisis

Interest rates growth  Weakening the position of the company: reducing the cash flow, non-anticipated decline in price levels, and reducing the net value of the company   Worsening the problem of asymmetric Growth of opportunistic behavior, information: an increase in adverse and Alternative institutions selection, and moral hazard growth   Decline in economic activity: decline in production, decline in aggregate output, and decline in aggregate demand

Source: Author’s creation

Due to the increased role of financial markets in the allocating the financial resources, central bank provides refinancing instruments. At least one of the tools (instruments) of the central bank is an official interest rate. In addition to managing the short-term money market rates, manipulation of official interest rates should contribute to designing the explicit intent of monetary policy and stabilizing the market expectations. This, further, should contribute to reducing the instability of interest rates. Due to disintermediation and financial innovations, there are changes in financial assets or increased volatility of monetary aggregates. This is another reason why central banks change the official interest rates, as a corrective measure, in order to make the stance of a monetary policy clear. The management of the central bank would be rather simplified if discount (base) rate was above the market or moved in accordance with them. The use of interest rates in the evaluation (implementation) of monetary policy in crisis conditions is based on insufficiently clear and/or argumentative (correct) interpretation of the role of interest rates. By establishing control over the flow of money and credit, in order to prevent anarchic fluctuations in the economy, the central bank uses its official interest rate (discount rate) as a classical monetary policy instrument. Changes in this interest rates on central bank’s loans have a significant effect on interest rates in the economy in general, although it reflects the movement of interest rates in the market. A larger number of market interest rates that exceed the discount rate have influenced the complexity of managing the discount window. The borrowings of depository institutions at the central bank have increased. Profitability has been achieved at the expense of the central bank: through lending at higher interest rates. The consequences of such financial system operations are: − imposing a serious moral hazard to the overall economy, − legalizing the mechanism through which the manipulative trading practices and prices in the so-called free market are being favored, and − abusing the monetary system. Generally, the accepted view is that the housing bubble, emerging financial crisis and the current economic difficulties are caused by expansionary monetary policy. Inadequate access to transmission is based on the following mechanism: in a recession, direction of monetary policy is expansive, low interest rates create a process of general increase of prices, which is a precondition of evolving the housing crisis in the financial crisis. Wrong interpretation of the effects of low interest rates on expansionary monetary policy implies inconsistency with the factual implementation of a restrictive monetary policy. Leaving aside the relation between supply and 117

Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 demand, as a basic determinant of interest rates, i.e. the possibility of displacing the official interest rates in both directions, the interest rates on the interbank market have produced the adjustment of discount rate. Simplicity of ongoing process of determination of interest rates, especially LIBOR, with totally routine process of factual calculations, results in indexing the extremely large scope of assets worldwide. The assessment of financial instruments, mainly consumer’s, worth hundreds of trillions of dollars is applicable to mortgages, loans for credit cards and cars, for more currencies and loan maturities. However, banks that participate in determining LIBOR rates are not obliged to borrow at these rates. Due to the absence of data on lending in the interbank market, it is unclear whether the loans were granted at these rates. Exhaustion of interbank liquidity (supply) is explained by the inclusion of exceptional growth in credit risk, which resulted in an interest rates increase. The general opinion is that the market for commercial paper probably provided data on prices and quantity. Since LIBOR itself is not sufficient as an indicator for the analysis, it is necessary to follow the spread with official (base) rate. The collapse of investment bank Lehman Brothers has influenced the level of LIBOR, and dramatic worsening of the crisis has led to the lowest level (3.54%) of three-month LIBOR after the bank collapse. Theoretically, it could be interpreted that a significant decline in interest rates of the central bank from 4.5 to 3% at the beginning of No- vember 2008, has led to a further lowering of LIBOR. In conditions before the crisis, with official interest rate of eg. 3%, LIBOR should be higher by 10 or 20 basis points. However, the inconsistency of relations between the two rates at the beginning of the credit crisis (August 2007) was a trend (Lakic, 2010, pp. 38-39). Despite the decrease of an official rate, relatively high level of LIBOR resulted (mid October 2008) in a significant increase in variable interest rates on mortgage loans. A bank bailout should influence the formation of LIBOR at a lower level, but reference interest rate in the UK rose above 6%. Although the liquidity inject into the banking system in the amount of 40 billion pounds (October 2008) had a positive sign, the impact on interest rates had limited (“moderate“) effect. Operating dominance of the market over the official interest rate can be thus obvious – Figure 3.

Figure 3. The inconsistency of the official and market interest rates (LIBOR, 12.11.2008)

Source: Author’s creation

Reducing the impact of interest rates of major central banks (i.e. the Fed) indicates that the control function of the Central Bank has no practical foundation. Namely, the central bank has a

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Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 partial possibility to move interest rates in both directions. Reduction of the discount rate, for example, can be interpreted as an indication of decision to increase the liquidity in the system. However, instead of deciding on the desired level of interest rates, the Federal Reserve had just followed the market. This reaction was evident after the fall of market rates in October 2000, followed by growth in June 2003, and finally fell again in February 2007. The Bank of Japan was also constantly adapting its target rate to maintain direction in line with developments (fall or rise) in the bond market. Practically, the drop of interest rates was not registered on bullish markets. This is a proof that direction of interest rates, rather than monetary authorities, has determined the changes in the market (speculators and/or manipulants) – Figure 4.

Figure 4. Dependence of the Central Bank’s reaction on the market (1995-2009)

Source: Author’s creation

Change of Treasury bills would cause immediate response of the target rate’s for the Fed Funds. Figure 4 shows the relation between target rate of the Federal Reserve and the 90-day Treasury Bill Yield. The first two quantitative easing of the Federal Reserve represent the bail- outs through constant manipulation of the money supply. Large amounts of bought securities had the alleged aim to increase liquidity and prevent growth of interest rates. Liquidity management of the Federal Reserve in the form of QE 3, argumented as “psychological uplift of the investors“, at the bond market has initiated: (artificial) manipulating the interest rates; attractiveness of investing in debt instrument (bonds). The significant increase in banks' profitability is the result of two factors: fixing the short-term interest rates at nearly zero level by the central banks (Fed, ECB); long-term growth of the interest rates caused by inflation. Starting from the previous analysis the conclusion is unambiguous: creating inflation by the central bank is in the interest of speculative and manipulative operations of the Wall Street’s institutions. Selective credit control as a common form of monetary intervention in the leading financial systems have enabled de facto power to corporate banks, through the so-called agreement and arrangement with the Central Bank, to redirect funds of primary issue in accordance with “national interests“. Selective mechanism of central-bank lending should be present in the economic systems where “market mechanism“ is not sufficiently effective, so the issuing bank was supposed to substitute the imperfection of the money market. Preventing specific purpose lend- 119

Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 ing left consequences for banks of small and medium size (non-corporate). In essence, linking of banking and industrial concerns derogates the influence of state agencies and at the same time creates a system of cross-ownership, usually under the dominant influence of the banks with the highest share of assets. This process is completed by implementing long-term practice of preventing the collapse of the banks that caused the crisis disorders, known as financial neoliberal approach “too big to fail“. F. Baring (1797), H. Thornton (1802) and W. Bagehot (1873) have seen the stabilizing role in the lender of last resort in crisis circumstances. The current crisis has caused collapse of several hundred small and medium-sized banks, and the government rescue has awarded the companies that basically failed at real market standards. US monetary system is an initiator and real brake of the the world financial system, even to the level of overall destruction. The Fed have approved 16.1 trillion of almost interest-free loans to the privileged (chosen) banks, and not only in the US. That is less than a third of 3.8% for interbank borrowings (20.10.2008) at one-month level. On the other hand, regardless of the increased capital, “a pretty good capital base“ is low compared to current liabilities, i.e. debt. A leverage of the Central Bank has increased more than 3.3 times compared to the 2008 crisis. The debt of banks in the balance sheet is enormous. The debt and the banking system are growing faster than the US economy more than 15 times in comparison to the pre-crisis period. All of this is a consequence of vertical schemes (position manipulation) of neoliberalism.

4. HIGH DERIVATIVE AND HIGH FREQUENT TRADING Derivative and high frequent trading are crucial segments of the financial system in terms of the total value (hundred trillion or quadrillion dollars) and speed of trading (milli or nanosec- onds). Initially designed in seventies to confront the risks of interest rates and currency, financial derivatives were then constructed for speculative operations, drastically surpassing the total assets of banks and, ultimately, shaped the extreme risky environment in the financial and, generally, the global economic system. Vertical paradigm of neoliberalism is supported by the exponential growth of a notional value of derivatives and, therefore, in the lack of adequate regulation, i.e. with regards to the market capitalization. Manipulation of derivative contracts derives from the observation that the price depends on, or is derived from the underlying assets, ie. the value is determined by fluctuations in an underlying asset. Financial derivative has no underlying value and is not an investment into anything realistic: it is a legal and highly leveraged bet (without control) on the future value or performance of something else. Comparison with the world GDP and assets of corporate banks indicates to:  fundamental (not formal) circumvent of the regulatory mechanism: protection or safety until a crisis occurs; regulation exacerbates the situation; implementation of regulation is not legally precise,  size of derivative market, potentially destructive: hypothetical value of an institution is equivalent to the several GDPs of the largest economy and exceeds the overall world economy,  absence of a mechanism for suppressing the bubble burst and spreading of derivative crisis: poor quality of derivative exposure; no access to the full information on prices and commissions; rapid breakdown which cannot be covered with money, and  disproportionate amount of derivative risk: a small number of institutions in the concentrated industry involves almost the full amount of exposure. Alternative institutions and alternative instruments are the pillars of neoliberal dogma, but they could also be a tool of overall destruction. Credit default swap (CDS) was created as an alternative instrument for the protection from default credit commitments, a product of significant confrontation to default risk of individual debtors, an arrangement which carries the risk of inability to collect a loan (in the form of bonds or loans). A holder of financial claim may transfer

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Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 credit risk to other transactor, who takes over the credit risk, the transfer price (premium) is paid by the buyer of protection against credit risk. When concluding the CDS arrangement, the protection seller (loan collateral) agrees to pay the receivable amount to the protection buyer, if he/she can not collect his/her receivables on loans or bonds of the company or state. CDS are similar to the instruments such as insurance policy or guarantees covering credit risks. CDS is sold by banks, hedge funds and insurance companies, charging a premium for providing insurance. When a customer experiences a default, the regulator is usually not present to make sure that the CDS seller has the money and is able to pay CDS insurance to the buyer. Problems of arrangement are: aggregate undercapitalization of the CDS seller, because their allocated reserves are a small portion of the required percentage to be paid the agreed sum of the insurance; false sense of security to the bond buyers, which contributes to the out- break of crisis (eg. Greek debt crisis). Namely, the CDS sellers have bought CDS in other insurance companies to protect them, as they considered, from merely possible bankruptcy of Greece. As buyers of CDS arrangements, countries come in a huge exposure and debt position at the slightest negative economic trend. From conditionally justified reasons of secrecy in concluding the CDS contracts, arises space for protectionist, corrupt and in cartel effects of global financial entities. The consequence is the so-called Crony capitalism, that finances and protects unofficially privileged companies and firms. The implications of institutional disposition of this instrument (arrangement) can be reflected in the following stages:  Manipulation pattern was achieved by establishing rating package of CDS contract, not by individual CDS contracts. Quotations serve the banks to hide enormous subprime lending positions i.e. index serves the speculators who bet on the decline and crisis of subordinate mortgage market. Trade occurs mainly in the OTC markets, which moves away from transparency in trade;  Regulation bypassing. The reform of the law on banks and financial institutions placed emphasis on regulation and clearing house, but the law did not specify the implementation thereof. In the beginning, consequences were delays and inefficiency, and also the effective lobbying the banks to prevent the implementation of the adopted legislation. Although through crisis, regulation and control of CDS trade was globally reduced to formal and su- perficial activity of regulators;  Instrument disposition. Package of rating CDS contract is a set CDS arrangements that are directly related to the movement of market index. The outstanding absurd consisted of the following: growing the rating package of CDS contracts, growing and full value of the index of the stock exchange (specifically ABX.HE Stock Exchange). The aforementioned disposition suggests an aggressive strategy of neoliberalism, also observed in ETFs, and  Implementation problem is identified in the following: The establishment of a small protective capacity of CDS, first by the sellers, later by customers, is an implementation problem. At the same time, holders do not want to activate the CDS. For effective implementation of the CDS arrangement the ideal conditions are the global economic crisis and recession. CDS are molded as suboptimal real decisions. High frequency trading (HFT) is a business model “within the market“ and complicated transaction through which the computers make tactical decisions in real-time to use the opportunities before others by dominating the market, starting from a fragmented and highly fluid trading in securities and derivatives, and complexity of predatory algorithms for the purpose of routing prices of instruments and making profit from artificial increase or reduction of prices. The theoretical basis of commercial algorithms is included in the Theory of market microstructure in modern interpretation (O'Hara, 2014; Aldridge, 2013; Christiansen, 2009; etc.). The theory does not emphasis the use of trading algorithms for speculative or, more precisely, manipulative operations in order to make more profit, while market risk is not so significant. The practice, however, does not suggest the reason for obtaining the best possible prices for an order (“algorithms for optimal execution“). Hence, high frequency trading is based on: 121

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 manipulative scope of operation, when the market scam (legal manipulation) is the cause of systemic risk,  practically legislated insider trading, based on predatory algorithmic trading strategies,  weakening of transparent price discovery, by hidden trade liquidity,  reduction of public liquidity, available to the conventional stock exchanges, and  destabilization of the market and threat to the financial security of citizens, while “financial elite“ harvest wealth by socially useless techniques. Empirical studies of determinants of high frequency trading are supporting previous findings. The prevailing opinion is that the primary causes of the (market) volatility are HFT and enormous trust in computer systems (Market Strategies International 2010; Kirilenko et al., 2014). Relatively recent research, such as F. Zhang (2010), suggest that HFT produces adverse effects on the capital market in the United States: increasing price volatility of stocks. Analysis show that high frequency traders do not contribute to the stabilization of prices during the un- usually volatile period. It has been proved (Huh, 2014) that under conditions of asymmetric information, the creation of markets through HFT provides less liquidity actions. High frequency traders, according to the analysis (eg. Brogaard et al., 2013), due to the informativeness, had an advantage in price efficiency and imposed the costs of adverse selection to other investors. According to S. Ghilani (2012), Capital Wave Strategist, high frequency trade is not fair, nor consistent in preserving the free and regulated markets, i.e. it is illegal.

Figure 5. Example of regulator’s “incompetence“ consequence

Legalized insider trading  Securities Commission (SEC)  Legal manipulation    Market-thwarting elec- Use of predatory algo- High frequency traders (HFT) tronic hijinks   rithms    Asymmetry of Artificial quidance Market manipulation information   price    Destabilization of Investors inferiority  Market (Flash) Crash  markets and the financial system

Source: Author’s creation

However, the essence of the vertical model functioning, as a part of most commercial operations of investment banks, is the guiding price of instruments by dominating the market, with a guaranteed profit (common market manipulation), and in trading with insider capital flows, which are unprotected and sold to the high frequency traders with exclusive advantage (legal insider trading). By inserting quotas on the market, high frequency traders try to deceive or provoke reaction of other market participants in adapting their quotas. “System defects“ consist of implicit response from the authorities (legislators, lobbyists, regulators such as the SEC), giving to HFTs the “license to steal from others“, which allows pulling money from uninformed (infe- rior) investor  small or large (pension funds). The so-called quants  mathematicians and physicists and rogue algorithms, unwilling and unable to quantify the risk, cause moral hazard and erode the fundaments (credibility and overheating) of the market.

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Slobodan Lakic, Mimo Draskovic / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 113-124 5. CONCLUSION: IMPLICATIONS OF DISPOSITION PARADIGMS Claims of prominent economists that the financial systems evolve at an accelerated pace towards a market-centrist, not a bank-centrist system (dominated by banks), are directed towards the creation of views on a lot more efficient system, and resource allocation, as well as lower volatility of the financial markets. In accordance with this view, market rules will curb all excessiveness, the state institutions will prevent fraud and abuse, and the public will be effectively informed. Quantitative models are supposed to hide the following facts: a) absolute market efficiency is impossible, b) perfect markets are a product of the economic theory structure, c) thesis on market rationality in determining the financial cost is indefensible, d) diversification can not prevent losses, and e) nonlinear development is characteristic of globally-linked markets in crisis. This, actually, justifies the market fundamentalism, funded in a vertical constellation of financial corporatism, which is a consequence of vertical strategy of domination. Corporatism represents an economic superiority, deciding factor and instrument of uncontrolled operations of corporate entities in relation to state entities (regulators, agencies, commissions). Modern technological progress and economic trends in the international framework, based on protec- tionism for one side and discrimination for another, have resulted in a homogeneous concentration of power: industrial  industrial corporations; financial  industrial and financial conglomerates. Nation-states have less power and follow the orders of the market, and large corporations completely dominate the political systems. Freedom of competition and advancement of individuals and small businesses usually is not permitted. In collectivist system, a liberal system of free enterprise is far from reality, with the rapid growth of economic inequalities and “elite“ control of the national wealth. Holders of monetary and liquidity management are the only official body that, at the height of the financial crisis, can quickly react by intervention mechanism. The current financial problems were “unusual“ regulatory interventional operations and “unconventional“ changes of monetary policy. Accordingly, the escalation of the financial crisis has had two repercussions in the monetary system: leading central banks cut their interest rates, which coincides with enormous increase in the price of housing; monetary policy has encouraged moral hazard, by credit- ing system, initiated by the mortgage loans of high risk profile. Traditional instruments of interest rates proved to be ineffective in the midst of the current crisis. First of all, there were reac- tions of central banks on long-term market changes that have already occurred. On the other hand, the mechanism by which speculators gain priority over other investors, is known as “tele- graphing the market“ by the monetary system managers. Generally accepted claim that the central bank is a “suppressor of financial distress“ has no real basis. It is evident that monetary authorities and government agencies are not able and/or do not tend to prevent a banking panic. Laws relating to the central bank formally em- power the monetary authorities in the broader economic context, but financial flows are actually determined and directed by mega banks that exist outside the relevant scope of an adequate regulation and supervision. Prudential regulation, lending in a last instance and deposit insurance are mechanisms that even exacerbate the consequences of economic downturns such as the recession, but also strengthen the financial supremacy of corporate banks. Financial derivatives are the one and high-frequency trading is the another fundamental market mechanism of institutional predator- ship, allowing the neoliberal disposition of the “market“ and “non-market“ participants: oligopolistic and/or monopolistic treatment of prices and sustainable market manipulation, are creating a bubble as real distortionary input.

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Aldridge, I. (2013), “Market Microstructure and the Risks of High-Frequency Trading“, Working Paper, Princeton Quant 2013 Conference, New York. Blanchard, O. (2003), Macroeconomics, Prentice Hall, London. Brogaard, J., Hendershott, T., Riordan, R. (2013), “High-Frequency Trading and Price Discovery“, European Central Bank Working Paper, No. 1602, Frankfurt am Main. Christiansen, J. V. (2009), “Financial Market Microstructure and Trading Algorithms“, AEF The- sis, Copenhagen Bussines School. Draskovic, M. (2009), “Globalna financijska kriza i neoliberalna dogma“, Ekonomija/Economics, Vol. 16, No. 1, 127-148. Draskovic, V. (2014), Neoliberal Metaphor  Quasi-economic paradigm, Elit-Rifin, Podgorica- Zagreb. Friedman, M., Schwartz, A. (1991), “Alternative Approaches to Analyzing Economic Data“, Ame- rican Economic Review, Vol. 81, No. 1, 39-49. Ghilani, S. (2012), “Wall Street Insight & Indicements“, Money Morning, Different Articles, Oct. Henderson, D. R., Hummel, J. R. (2008), “Greenspan’s Monetary Policy in Retrospect: Discretion or Rules“, Cato Journal Briefing Papers, No. 109, 1-9. Huh, Y. (2014), “Machines vs. Machines: High Frequency Trading and Hard Information“, Fede- ral Reserve Board, Staff Working Papers, New York. Kirilenko, A., Kyle, R. S., Samadi, M., Tuzun, T. (2014), “The Flash Crash: The Impact of High Fre- quency Trading on an Electronic Market“, Social Science Research Network (Electronic Pub- lishing), New York. Krugman, P. (2009), “How Did Economists Get It So Wrong?“, The New York Times, September 6, 36-43. Lakic, S. (2010), “Monetary Management And Control Under Uncertainty And Crisis“, Monte- negrin Journal of Economics, Vol. 6, No. 11, 35-48. Lakic, S. (2012), “Corporatism as a Totalitaristic Foundation and Practicism“, Montenegrin Jour- nal of Economics, Vol. 8, No, 2, 275-294. O'Hara, M. (2014), “High Frequency Market Microstructure“, Johnson Graduate School of Man- agement Working Paper, New York. Stiglitz, J. E. (2014), “Tapping the Breaks: Are Less Active Markets Safer and Better for the Eco- nomy“, Presented at the Federal Reserve Bank of Atlanta (April 15), Financial Markets Con- ference: Tuning Financial Regulation for Stability and Efficiency. Zhang, F. (2010), “The Effect of High-Frequency Trading on Stock Volatility and Price Discovery“, Working Paper, Yale University, New Haven.

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Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 125-135 ‘

The Day-ahead Energy Market Forecasting in Russian Federation: a Case Study of Siberia

Alexander Filatov1, Evgeny Lisin2, Evgenya Smirnova3

1 Assoc. Professor, Irkutsk State University Institute for Mathematics, Economics and Computer Science, e-mail: [email protected] 2 Assoc. Professor, Department of Economics in Power Engineering and Industry National Research University “Moscow Power Engineering Institute”, e-mail: [email protected] 3 M. Sc. Irkutsk State University Institute for Mathematics, Economics and Computer Science, e-mail: [email protected]

ARTICLE INFO ABSTRACT Received September 12, 2015 Recent reforms in Russian power industry and the wholesale Received in revised from - electric power and capacity market construction put energy Accepted December 04, 2015 companies into the new competitive conditions. Due to these Available online December 07, 2015 reforms, the issues of price and quantity forecasting at the day- ahead market (DAM) gain special importance. Particularly, the JEL classification: extrapolated values of the prices and quantities at DAM are C02; Q40; Q43 necessary for the regulator, and also for energy companies to work out the best market strategy. DOI: The current Russian wholesale electricity market represents a 10.14254/1800-5845.2015/11-2/8 fundamentally new model of the electric power industry that functions on a competitive basis. The key role in the structure of Keywords: the wholesale energy trading sector is played by the day-ahead electricity sector that provides up to the 80% of total electricity Energy, sales in the country. As a result of the auction clearing, the Wholesale electricity market, market price for all points in the supply of electricity is formed Power, and the volume of the market is determined. There is also a Day-ahead energy market, need for forecasting the equilibrium price and quantity of elec- Marginal pricing, tricity sales, which largely determine the strategies of generation Generator strategy companies from the perspective of the use of free electric pow- Time series, ers. This paper proposes a method of construction of medium Russian Federation and long-term forecasting of the DAM’s main characteristics. Our results that stem from the mathematical model and statistical data reveal the most significant factors and quantified their nature, their extent as well as their effect on the energy market of Siberia.

1. INTRODUCTION Currently, Russia’s wholesale electricity and power market (formally known as OREM) comprises a totally new framework of business transactions in the electric utilities industry, with a competitive environment that shares many properties of “perfectly contestable markets”.

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Alexander Filatov, Evgeny Lisin, Evgenya Smirnova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 125-135 The OREM model follows the rules of deregulated electricity markets while paying heed to specific Russian nuances and incorporates the experience of PJM Interconnection, one of the world’s first deregulated electricity markets that has brought together transmission networks operated by utility companies in the states of Pennsylvania, New Jersey, Maryland, Delaware, Virginia, and Ohio (see e.g. Borenstein, 2002; or Pittman, 2007). The emergence of electricity markets in US and most-advanced European countries in late 20th century was driven by the growing discontent with the quality of services provided by a number of natural-monopoly industries as well as accelerating globalization trends and the birth of unified global markets. The wholesale electricity and power market is comprised by three electricity trading sectors:  Bilateral contract market (BCM)  Day-ahead market (DAM)  Balancing market (BM). At the bilateral contract market electricity is traded under regulated and free bilateral contracts. In the regulated sector, rates for electricity supplied to and bought at the wholesale market are set by the Federal Tariff Service of Russia. The day-ahead market is used to sell/buy excess/lacking amounts of electricity to comple- ment quantities traded in bilateral contracts. Electricity is traded at DAM at prices influenced by supply and demand. The balancing market accommodates deviations of actual hourly output/consumption figures from the scheduled electricity trading quantities and serves to balance supply against demand in real time. Rewards are paid to generators who adjust their electricity output in response to System Operator’s (SO) initiative; at the same time, generators reducing their output unilaterally as well as load-increasing consumers are penalized with extra charges (Lisin, Grigoryeva, 2012); Lisin et al,2014; Makarenko, Streimikiene, 2014).

Figure 1. Offer submission flowchart for VSVGO and DAM

Generator Electricity companies retailers

Q ,Q ,P ,P VSVGO P ,Q min max G G QG,PG  PG R R

VSVGO DAM

P *, Q G , Q R  G

Note: PG, PR, QG, QR – are the prices and quantities of generator and retailer companies, Qmin and Qmax are technically feasible minimum and maximum power outputs, P* is the equilibrium price, G is a Boolean variable (1 or 0 for the online/offline output condition of generating unit of generator G taking part in VSVGO, at the end of the period in question) Source: Own results

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Alexander Filatov, Evgeny Lisin, Evgenya Smirnova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 125-135 Sales at DAM are preceded by a bidding procedure for selecting generator plant to be brought online, known as VSVGO and carried out a week ahead of the trading day. Prices from offers submitted by generators for VSVGO then serve as ceiling prices for offers submitted to DAM and BM markets throughout the following week. The diagram above (Figure 1) illustrates the influence VSVGO bidding has on DAM trading outcome. Figure 2 shows a graphical interpretation of the price discovery model for the day-ahead market. Only in a single potential situation may the consumer act as a price-setter when bidding for electricity (Figure 2a). In all other instances (Figures 2b, 2c), a generator’s offer sets the price (see Stoft, 2002; Lisin and Strielkowski, 2014; Nicolaisen et al, 2001; or Melnik and Mustafina, 2013).

Figure 2. Price discovery at the day-ahead market

Source: Own results

Typically, generating companies begin with the marginal strategy, submitting their offers at prices equal to electricity generation cost that only includes variable costs. The marginal strategy calls for submitting offers based on marginal costs i.e. the relative increase in production cost per megawatt-hour output. It is known that the optimum utilization of power plant has no relation to its semi-fixed costs. For that reason, variable costs are included in the expense function. A generator may benefit from submitting offers using the marginal cost strategy only when all market players follow the same strategy. Power plant will be loaded most efficiently in this case while the market price and volume will be close to the competitive equilibrium point. Generating companies can also use market power, based on physical and financial withdrawal of power plant generating capacity. Physical and financial withdrawal are two market strategies that seek to remove a part of low-priced offers from the market either by raising price or by minimizing underpriced supply. Table 1 shows the potential value that may be obtained by applying them. The prices and quantities forecasting at DAM allows generation companies work out more effective strategies in order to sell electric power ate a reasonable price and to obtain profit even in situation of the high price volatility (Borenstein, 2000; Simionescu, 2013). Also among the main objectives of the construction of medium and long-term forecasting at DAM procedure we can mention the following:  Providing the effective regimes of the power plants work.  Improvement of the business planning at generation companies.  Improvement of the generation companies behavior at the wholesale market on the base of the best option choice between trade operations at DAM, long-term bilateral contracts, and forward contracts that allow risk hedging.

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Table 1. Basic strategies available to generators for exercising market power

Strategy name Application mechanism Outcome Financial withdrawal Place electricity supply offers In a demand-dominated market (with at a higher price (exceeding demand becoming inelastic) this should marginal electricity production increase the equilibrium market price and costs in particular). potential generator’s revenue as a consequence. Physical withdrawal Offer reduced amounts of A part of the supplied power is taken away electricity at the market from the market causing the equilibrium relative to the full output price to go up. capacity of company's generator plant. Physical withdrawal by Make free bilateral contracts This will make the equilibrium market price means of free bilateral aiming to reduce the amount go higher if electricity consumption contracts of cheap product offered at increases. the market.

Source: Own results based on (Stoft, 2002; Nicolaisen et al, 2001; Melnik and Mustafina, 2013)

2. THE DAILY EQUILIBRIUM PRICE FORECASTING AT DAM The daily price forecast is based on statistical data about adjusted by CPI (Rosstat, 2015) electricity prices at DAM (second price zone – Siberia) for 7 years (09.2007–08.2014) provided by (Russian Trading System Administrator of the Wholesale Electricity Market, 2015) (see Figure 3).

Figure 3. Dynamics of adjusted by CPI electricity prices at DAM (09.2007-08.2014)

Source: Own results based on (Russian Trading System Administrator, 2015)

We included into the model the following regressors (Davidson et al, 2009): trend (t), dummies for the days of week (z(1)–z(6)) and holidays (z(7)), the share of working turbines at Sayano- Shushenskaya power station (essential due to the 2009 year catastrophic accident) (z(8)), average day temperature (x(1)) and light day duration (x(2)) (The Weather Schedule, 2015), adjusted oil (x(3)) and natural gas (x(4)) prices (Market and analytics “Finam”, 2015), dollar (x(5)) and euro (x(6)) exchange rates (Central Bank of Russian Federation, 2015), Russian GDP (x(7)) (Rosstat, 2015).

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Alexander Filatov, Evgeny Lisin, Evgenya Smirnova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 125-135 Some other regressors were excluded from the model due to their insignificant impact on electricity prices. We also excluded from the final version of the model temperature correlated with light day duration, oil price correlated with gas price, and dollar exchange rate due to high correlation with euro – all excluded variables were less significant than the included ones. The identification of the linear multiple regression revealed the following:

yˆ  1055,7 0,214t**  24,71z 1** 19,11z 2** 18,15 z 3 **  34,9 0,009  5,54 5,53 5,53 18,61z 4 ** 18,71z 5 ** 13,42 z 6 * 16,90 z 7 *  31,15 z 8 **  (1) 5,53 5,52 5,53 (7,37) (4,40)  0,069 x2 **  0,0069 x4 ** 16,15 x6 **  0,0059 x7 * 0,008 0,0016 0,63 0,0018

The determination coefficient and the standard error are equal to Rˆ 2  0,668, and ˆ  74,52 respectively. Variables marked with one and two asterisks denote regressors significant at level of 5% and 0,1% respectively. The behavior of residuals is described by the first order autoregression AR(1):

 (t)  0,759 (t 1)   (t) (2)

The determination coefficient, thus, becomes equal to Rˆ 2  0,859 and the standard error decreases to ˆ  48,42. At the same time in real life dependent variable isn’t often changed instantly, directly after the change of regressor, but after a while which is called temporary lag. Moreover this influence is usually distributed in time. Particularly the DAM electricity price is influenced by the gas price, however fuel isn't delivered to power plants instantly, so it’s better to consider the model with the distributed lag (Draper, Smith, 2014); (Galwey, 2014). We will use the Koyck lag structure combined with linear trend, dummies for the days of week, and exogenous factors. The modelling is divided into the three stages. 1. Identification and elimination of trend and cycle:

yˆt  397,0 0,133t**  24,88 z 1** 19,44 z 2** 18,48 z 3 **  (5,6) 0,002 6,42 6,41 6,41 (3) 19,02 z 4 ** 18,90 z 5 ** 13,29 z 6 *  4,32 z 7  24,10 z 8 **  lt . 6,42 6,41 6,42 8,39 4,33

2. Application of Koyck transformation for the natural gas price: ** 4 lt  0,821lt 1  0,00008 x  mt (4) 0,011 0,00024

3. Identification of the other factors impact: mt  76,54 0,012 x2*  2,21 x4**  0,0017 x6 ** (5) 11,65 0,005 0,31 0,0004

The determination coefficient for the final model becomes equal to R2  0,857, and the standard error decreases to ˆ  48,66 even though we didn’t use the ARMA-models for residuals here. 129

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Value ˆ  0,821 in the Koyck model means that the gas price change is transferred to the DAM electricity price almost immediately. After a week from the initial influence there is slightly more than a quarter left, a month later – only 0,3%. At the same time it’s impossible to ignore the distributed log. The model shows very high significance of the lagged variable. The robustness analysis was also carried out in this paper. As a result, it was stated that including into the model additional insignificant regressors or model identification on subsamples didn’t considerably change coefficients.

3. THE DAILY QUANTITY FORECASTING AT DAM The second step in our research was the quantity forecasting at DAM. The quantity (y) dynamics for 2007–2014 is presented at Figure 4.

Figure 4. Quantity dynamics at DAM

Source: Own results based on Russian Trading System Administrator (2015)

Figure 4 shows that there was considerable quantity increase during 2008-2011. It was connected with agents transfer from the bilateral contracts to the day-ahead market. The process wasn’t uniform. We can see half-year shifts in quantity arises after the fixed-date contracts’ expiration on the 30-th of June and on the 31-st of December). This effect was investigated using dummies (g(i)) for each half-year interval. We also used the same regressors together with adjusted by CPI price (x(8)) to forecast quantities. The model (Filatov and Smirnova, 2012) constructed on the data of 2008-2011 showed the following results: yˆ  420,05 0,04 t **  4,19 z 1*  4,34 z 2*  4,25 z 3*  4,21z 4 *  32,91 (0,01) (2,17) 2,14 2,13 2,13  5,09 z 5 ** 17,68 z 7 **  30,40 z 8 **  447,20 g 1 **  409,86 g 2 **  2,14 3,65 4,68 17,37 14,98 (6)  368,95 g 3 **  262,45 g 4 ** 189,34 g 5 ** 113,93g 6 **  56,79 g 7 ** 11,88 10,12 7,92 5,61 3,76  0,85 x1 **  0,09 x2 **  0,010 x4 **  2,08 x6 **  0,11 x8 ** 0,11 0,01 0,001 0,60 0,01 One can observe that the price is positively significant. It particularly means that generation companies, but not consumers dominate at DAM. It’s opposite to the results obtained for Euro- pean Union and even for the first price zone of Russia, but this situation is possible for highly concentrated markets, like energy market of Siberia.

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Alexander Filatov, Evgeny Lisin, Evgenya Smirnova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 125-135 In the long run average quantities were approximated by the logistic function. It’s interesting that the proposed forecast turned out to be quite exact. For example, on the base of cali- brated on data of 2008-2011 model (Filatov and Smirnova, 2012) we estimated the peak volume for 2014. Model showed that it had to be yˆ  591,47 on the 28-th of January. In reality peak volume was yˆ  603,16 one day later.

4. THE HOURLY PRICE FORECASTING AT DAM

The third direction is connected with hourly forecast at DAM. It is essential to carry out preliminary processing – to eliminate outliers and to smooth the peak prices using moving average of 3 i i and 5 points. Then we included into the model real factors x , dummies z for days of week i and holidays, and dummies ~z for hours: 5 7 ~ 23 ˆ i i ~ i y  c   t  i x  di z  di z (7) i1 i1 i1 All coefficients and the significance level for each regressor are presented in the Table 1. Let us note that all regressors presented here are significant.

Table 2. Coefficients and significance level for hourly models

MA (3) MA (5) Regressors Coef. Sig. Coef. Sig. c Const 229,38 0,01 233,08 0,01 t Trend 0,01 0,01 0,01 0,01 1 0 x Day temperature ( C) –1,17 0,01 –1,16 0,01 2 x Light day duration (min) 0,07 0,01 0,07 0,01 3 3 x Gas price (RUB/1000m ) 0,46 0,01 0,46 0,01 4 x Dollar exchange rate (RUB) –6,39 0,01 –6,40 0,01 5 x Euro exchange rate (RUB) 4,10 0,01 4,06 0,01 1 ~z Hour 1 (00:00–01:00) –0,24 0,05 1,31 0,05 2 ~z Hour 2 3,22 0,05 6,83 0,01 3 ~z Hour 3 13,6 0,01 15,56 0,01 4 ~z Hour 4 28,18 0,01 26,26 0,01 5 ~z Hour 5 41,64 0,01 37,11 0,01 6 18 ~z – ~z Hour 6 – Hour 18 54,74 0,01 52,79 0,01 19 ~z Hour 19 44,54 0,01 39,43 0,01 20 ~z Hour 20 29,10 0,01 29,23 0,01 21 ~z Hour 21 14,72 0,01 17,49 0,01 22 ~z Hour 22 6,16 0,01 8,15 0,01

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23 ~z Hour 23 2,10 0,05 2,49 0,05 1 z Monday 18,21 0,01 17,93 0,01 2 3 z z Tuesday–Wednesday 14,61 0,01 14,39 0,01 6 z Thirsday 13,52 0,01 13,36 0,01 6 z Friday 15,44 0,01 15,29 0,01 6 z Saturday 10,36 0,01 9,97 0,01 7 z Holiday 5,69 0,01 5,72 0,01 R2 0,31 0,30

Source: Own results

The determination coefficients of both modifications are quite the same – both models explain about 30% of hourly price variation. We can also use the first order autoregression AR(1). It will greatly increase the quality of forecast:

МА(3): ε(t)=0,98ε(t–1)+δ(t), Rˆ 2  0,96, σ = 8,91 MА(5): ε(t)=0,92ε(t–1)+δ(t), Rˆ 2  0,98, σ = 6,52

Another way how to make the hourly forecast – is to use the extrapolation model based on a method of a maximum likeness (17-19). It is based on the fact that if the general influence of all factors during any period of time had led to a certain profile of process, sooner or later process again would have a profile similar to initial (see Figure 5). The pairwise correlation was chosen as a measure of likeness.

Figure 3. Graphic representation of maximum likeness method

Source: Own results

On the basis of original data it was possible to find the optimal length of a vector M (168 hours that is equal to one week), and optimal length of moving average (5 points). It allowed reducing the standard error to ˆ 1,68 (Figure 6).

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Alexander Filatov, Evgeny Lisin, Evgenya Smirnova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 125-135 Figure 6. Optimal solution of maximum likeness method

M *  168;  *  1,68

Source: Own results

4. Conclusions and discussions The main valued-added and the major result of the study is the development of the method that allows us to construct the medium and long term forecast of the main characteristics of the daily trade in the electricity sector, namely in the day-ahead market. The method presented in our paper is based on the construction of models that employs regression framework. Within the framework of the statistical research, the most significant factors were revealed and the nature and extent of their influence on the resulting performance of the energy market of Siberia were quantified. The results were presented and described in a comprehensive way. Our study was conducted based on the standard model of multiple linear regression and took into account the timing of the effect of covariates (e.g. natural gas prices), as well as diur- nal variations of the price using the maximum likelihood method. The developed method of prediction may be used by the generating companies in the preparation of optimal strategies for implementing free electric power from the perspective of profit maximization and control of the electricity market to optimize the operation and management of the current market. It becomes apparent that on the basis of the scenario approach one can analyze the dynamics of the energy market by substituting the predicted values of the interval factors in the regression equation. Furthermore, the paper considers the worked-out techniques of the medium and long-term price and quantity forecast at the day-ahead market and the results of its calibration on the data of the Second Price Zone of Russia (Siberia). We revealed the most significant factors that impact DAM price and quantity, including geographic, economic, weekly cycles, etc. In particular, we found positive linear trend, seasonality in prices and quantities, positive shifts in quantities on the 1st of January and the 1st of July, significant impact of prices on fuel, exchange rates, as well as the impact of the Sayano-Shushenskaya power plant accident. Moreover, it is interesting that Monday significantly differs from the other days of week, and that prices during the holidays are even lower that on Sunday. We also checked sustainability of the coefficients, analyzed the distributed in time influence of some variables, and investigated intra-day price volatility. The technique elaborate in this paper can be used by generation companies working out optimum market strategies, and also by the social planner constructing mechanisms of better market regulation.

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Acknowledgements: The reported study was partially implemented within the framework of research project No. 26.1795.2014/K supported by the Ministry of Education and Science of the Russian Federa- tion. The work was also supported by RFBR grant No.13-06-00152 The research leading to these results has received funding from the People Programme (Marie Curie Actions) of the European Union's Seventh Framework Programme FP7/2007- 2013/ under REA grant agreement number 609642.

REFERENCES

Borenstein, S. (2000), “Understanding competitive pricing and market power in wholesale electricity markets”, The Electricity Journal, 13, 49-57. Borenstein, S. (2002), “The trouble with electricity markets: Understanding California’s restructuring disaster”, Journal of Economic Perspective, 16, 191-211. Chuchueva, I. (2009), “Seasonal regression model for the problem of DAM prices forecasting”, Energy Info, 4, 46-49. Davidson, M.R. et al. (2009), “Mathematical model of power system management in conditions of a competitive wholesale electric power (capacity) market in Russia”, Journal of Computer and Systems Sciences International, 48, 243-253. Draper, N.R., Smith, H. (2014), Applied regression analysis, John Wiley & Sons. Filatov, A., Smirnova, E. (2012), The Electricity Price and Quantity Forecasting at the Day-Ahead Market. Scientific Enquiry in the Contemporary World: Theoretical Basics and Innovative Approach. L&L Publishing, Titusville, FL, USA, 47–50. Galwey, N.W. (2014), Introduction to mixed modelling: beyond regression and analysis of variance,John Wiley & Sons. Hylleberg, S. (2014), Seasonality in regression, Academic Press. Lisin, E., Grigoryeva, A. (2012), “Generators’ strategic behaviour reserch based on the agent approach to the power market modeling”, Czech Journal of Social Sciences, Business and Economics, 1, 75-81. Lisin, E., Strielkowski, W. (2014), “Modelling New Economic Approaches for the Whosale Energy Markets in Russia and the EU”, Transformations in Business and Economics, 13, 566-580. Nicolaisen, J., Petrov, V., Tesfatsion, L. (2001), “Market power and efficiency in a computational electricity market with discriminatory double-auction pricing”, Evolutionary Computation, 5, 504-523. Lisin, E., Strielkowski W., Amelina, A., Konova, A., Cabelkova, I. (2014), “Mathematical approach to wholesale power and capacity market regulation”, Applied Mathematical Sciences, 8, 7765-7773. Makarenko, D., Streimikiene D. (2014), “Quality of life and environmentally responsible behavior in energy sector”, Journal of International Studies, Vol. 7, No 3, pp. 179-192. DOI: 10.14254/2071-8330.2014/7-3/17 Melnik, A.N., Mustafina, O.N. (2013), “The Organization of Russian Power Market in Modern Conditions”, Middle-East Journal of Scientific Research, 13, 91-94. Pittman, R. (2007), “Restructuring the Russian electricity sector: Re-creating California”, Energy Policy, 35, 1872-1883. Simionescu, M. (2013), “The Use of VARMA Models in Forecasting Macroeconomic Indicators”, Economics & Sociology, Vol. 6, No 2, pp. 94- 102. DOI: 10.14254/2071-789X.2013/6-2/9 Stoft S. (2002), Power System Economics: Designing Markets for Electricity, IEEE Press, Hobo- ken, New Jersey.

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Alexander Filatov, Evgeny Lisin, Evgenya Smirnova / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 125-135 Central Bank of Russian Federation (2015), Available at: http://www.cbr.ru (accessed: 2015, November, 1). Market and Analytics «Finam» (2015), Available at: http://www.finam.ru/analysis/macroevent (accessed: 2015, November, 1). Russian Trading System Administrator of the Wholesale Electricity Market. Available at: http://www.atsenergo.ru/results/rsv/oes/index.htm (accessed: 2015, November, 1). Rosstat (Federal State Statistics Service). Available at: http://www.gks.ru (accessed: 2015, November, 1). The Weather Schedule. Available at: http://www.weather.com/weather/monthly/l/RSXX0038 (accessed: 2015, November, 1).

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Radosław Trojanek / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 137-145

Montenegrin Journal of Economics

Vol. 11, No. 2 (2015), 137-145 ‘

The Relation Between the Attractiveness and Value of Districts in Warsaw

Radosław Trojanek 1,

1. Assoc. Professor, Department of Microeconomics, Faculty of Management, Poznań University of Economics, e- mail: [email protected]

ARTICLE INFO ABSTRACT Received July 22, 2015 The aim of the paper is to answer the question to what degree Received in revised from Oct. 21, 2015 the attractiveness of living in a particular district is reflected in Accepted December 12, 2015 the value of a given area. In this paper, it was undertaken to Available online - compare the attractiveness of the districts of Warsaw (information obtained from the study of MSO) to their value (assessed JEL classification: on the basis of the econometric model of apartment prices). By E32; R33; P21 including location attributes (e.g. the location of apartments within districts) in the model, it will indirectly become possible to DOI: estimate their value. DOI: 10.14254/1800-5845.2015/11-2/9

Keywords: Attractiveness of districts, Value of districts, Hedonic methods

1. INTRODUCTION An apartment is a product that distinguishes itself from other goods produced and con- sumed by people. It satisfies the basic need of shelter. When choosing an apartment to buy, consumers consider two criteria: their preferences (regarding the size, type of building, and, first of all, location) and financial resources available to them (budget limitation).The primary need, i.e. location, may be satisfied practically everywhere (as regards location). It does not matter whether the apartment is located in the city centre or in its outskirts. The choice of a specific location depends on the preferences of a given consumer (budget limitations also play an important part here, but it may be assumed that if a consumer does not want to live in a given area, they would not buy an apartment there; the situation is different if they would like to settle in a given location, but they cannot afford it) and may depend on factors such as: the distance from work, schools, and hospitals, the accessibility of public transport, positive or negative neighborhood (both with regard to neighboring properties and environmental elements). Loca- tion is believed to be the main determinant of the value of a property. The choice of an apart- 137

Radosław Trojanek / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 137-145 ment in a particular district is determined by, among other things, the degree to which a specific location can satisfy consumers’ needs. The more attractive a given area is (from the perspective of living there), the more valuable it may be. In 2013, the Main Statistical Office (GUS – Główny Urząd Statystyczny) published a ranking of districts in Warsaw according to the attractiveness of living conditions. In the study, living conditions were defined as the level of infrastructure and factors affecting the degree to which needs are satisfied. The ranking and the characteristics of particular districts were compiled with the application of variables of a measurable character, which were available and complete: the number of people entitled to social security benefits per one thousand of the population, the proportion of the size of parks, greens, and urban greenery to the total area (%), the percentage of transportation areas to the total area (%), the number of people per one cultural institution, including cinemas, theatres and museums (combined), the number of children in kindergartens per one thousand children in the age of three to six, the number of pupils per one computer with Internet access in primary schools, the number of people per one pharmacy, the number of people per one library, the number of people per one store, and the length of cycling paths (in km). The ranking of districts was created on the basis of a synthetic indicator. The value of a given location should be related to its attractiveness. How valuable a given area is may be established on the basis of undeveloped areas. What is a common problem with reference to cities is the inability to apply this method. Another solution is the application of the hedonic method to identify the features affecting the value of apartments. By including location attributes (e.g. the location of apartments within districts) in the model, it will indirectly become possible to estimate their value [Cheshire and Sheppard 1995; Rosenthal 1999; Rossi- Hansberg et al. 2010; Trojanek, 2010, 2015] . In this paper, it was undertaken to compare the attractiveness of the districts of Warsaw (information obtained from the study of GUS) to their value (assessed on the basis of the econometric model of apartment prices). The aim of the paper is to answer the question to what degree the attractiveness of living in a particular district is reflected in the value of a given area.

2. RESEARCH METHODOLOGY AND THE SOURCES OF DATA Warsaw is the capital of Poland. It is the biggest and best developed Polish city, as well as an important scientific, cultural, political and business center. In statistics concerning social and economic development, it compares favorably to other largest Polish cities. In some areas, its potential is so high that it could be compared to the potential of the whole provinces of the country. In order to estimate the value of districts in Warsaw the hedonic equation of apartments prices was constructed. By including location attributes (e.g. the location of apartments within districts) in the model, it will indirectly become possible to estimate their value. The essence of the hedonic method lies in the assumption that the price of heterogeneous goods may be described with its attributes. In other words, this method may be used for estimating the value of particular attributes of a given product. In order to identify the influence of individual features on the value of a specific good, econometric equations are constructed. The price of a given good is the response variable, whereas its quantitative and qualitative attributes are the explanatory variables. The equation may be recorded in the following way : K P   0   i X i  u i1 ; (1)

where:

P – price of a good

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Radosław Trojanek / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 137-145 β – regression coefficient X – attribute of a good (value driver) u – random error.

The key issue in hedonic methods is to choose the form of the regression function. The log- linear form of the regression function is most frequently used for studying changes in the prices in the real estate market in empirical research: K log P   0   i X i  u i1 ;(2)

In order to estimate the value of a district location the information on asking prices of dwellings in Warsaw in 2014 (4th quarter) year was collected. The use of asking prices is determined by the fact that in Polish conditions, the access to information on features of sold dwellings is limited. The data included in notarial deeds are the most valuable source of information on real estate prices, but they have one drawback – they do not provide a full description of a property.

Figure 1. Districts of Warsaw

Source: Author’s creation

Table 1. The statistical characteristics of asking prices

Number of Average area of Average price Average price per District offers apartment (m2) (in €) 1m2 (in €) Bemowo 1196 65,17 116 467,61 1 797,57 Białołęka 832 58,05 87 888,33 1 534,62 Bielany 941 56,85 102 596,38 1 822,22 Mokotów 2128 65,19 145 673,63 2 192,23 Ochota 839 66,35 134 411,13 2 030,45 Praga-Południe 1468 61,31 113 422,32 1 847,34 139

Radosław Trojanek / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 137-145 Praga-Północ 360 53,62 90 010,05 1 687,01 Rembertów 36 56,32 88 703,70 1 600,66 Śródmieście 1569 65,09 168 561,01 2 590,06 Targówek 717 54,65 85 317,06 1 571,51 Ursus 458 59,60 97 626,98 1 652,53 Ursynów 1250 70,50 139 749,70 1 998,20 Wawer 88 73,95 121 872,56 1 666,34 Wesoła 46 70,63 103 797,77 1 496,00 Wilanów 433 81,60 177 308,03 2 141,49 Włochy 246 65,27 113 077,33 1 738,99 Wola 1053 54,43 110 738,99 2 015,12 Żoliborz 504 62,24 142 311,49 2 228,23 Total 14164 62,98 126 185,81 1 987,26

Source: Own calculations

3. THE ATTRACTIVENESS OF DISTRICTS IN WARSAW IN LIGHT OF MAIN STATISTICAL OFFICE RESEARCH According to the results of the research made by Main Statistical Office the following four districts from group 1 had the highest level of the attractiveness of living conditions in Warsaw: Śródmieście, Mokotów, Ochota and Wola. The district of Śródmieście took the leading position in this group. Śródmieście, as the oldest and relatively small district in terms of size, has dense urban housing as well as highly developed infrastructure and transportation network. Owing to its convenient transport connection with other districts, Śródmieście is an attractive location for company offices, public administration, cultural and entertainment centers, museums, galleries, cinemas and theatres. Thanks to well-developed service, health and educational infrastructure, and to the access to cultural facilities, Śródmieście offers the most attractive living conditions. Three districts adjacent to Śródmieście – Mokotów, Ochota, and Wola - also had a high level of the level of the attractiveness of living conditions. What contributed to the high level of this indicator in the district of Mokotów was the length of cycling paths – it accounted for more than 13% of the value of the indicator (equal to 100). In the district of Ochota, good access to cultural facilities – cinemas, theaters, museums (combined, measured as the number of people per one facility) was the main determinant: the value of this variable constituted almost 14% of the value of the indicator. In the district of Wola, in turn, it was the proportion of transportation areas to the total area of the district (over 15% of the value of the indicator) that had the most significant influence. The group with the lowest level of the attractiveness of living conditions included three districts: Bemowo, Ursus and Białołęka, the last of which occupied the lowest position. Białołęka, as a relatively young district, is currently experiencing investment boom, but its infrastructure is still out of proportion to the number of people settling there. Therefore, the low value of the attractiveness indicator was largely determined by poor access to health infrastructure (healthcare centers) and to cultural facilities (cinemas, theaters, museums). The values of these variables in the structure of values of the synthetic indicator were 0%. The districts of Ursus and Bemowo also had a low level of the attractiveness of living conditions. What had a negative impact on the value of the synthetic indicator in Ursus was poor access to libraries and the big number of people per one computer with Internet access in

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Radosław Trojanek / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 137-145 primary schools – the values of these variables accounted for 0% of the value of the synthetic indicator. In the district of Bemowo, it was low availability of pharmacies that represented 0% of the value of the indicator.

4. THE ESTIMATION OF DISTRICTS VALUE IN WARSAW In order to estimate the value of district in Warsaw the hedonic model was built. By including location attributes (e.g. the location of apartments within districts) in the model, it was indirectly possible to estimate their value. In the analysis, asking prices of residential units in Warsaw in 2014 (4th quarter) were used. Empty and recurring records were removed as well as those in which a specific offer was not fully described. The recurrence of data was the result of announcing one offer by a few estate agents, thus they were repeatedly placed in a database. The next stage of the analysis involved checking the reliability of obtained data. The aim was to eliminate those offers which were, for no clearly specified reasons, far from the average. Moreover, it was assumed that the analysis will cover dwellings with the floor space of up to 200 m2 and having no more than five rooms. Both fully owned dwellings and the ones with a limited right of ownership were examined. As a result of such selection the size of the database was reduced to 14 000 dwellings for sale. The number of offers gathered meets the requirements of the representativeness of a sample. The research was done with the application of the hedonic method based on the housing price regression equation. The choice of qualitative and quantitative variables was limited by the availability of information in the database. Table 2 presents the variables used in the research.

Table 2. Qualitative and quantitative variables applied in the model

Variable Symbol Description district1-Śródmieście, district2-Białołęka, district3-Bielany, district4-Mokotów, district5-Ochota, district6-Praga Południe, district7-Praga Północ, district8- Rembertów, 18 time dummy variables. district9-Bemowo, If the dwelling is located in a given District district10-Targówek, district, it takes the value 1; district11-Ursus, district12-Ursynów, dis- otherwise it takes 0. trict13-Wawer, district14-Wesoła, dis- trict15-Wilanów, district16-Włochy, dis- trict17-Wola district18-Żoliborz Time of construction1 – before 1939 Time of construction2 – from 1945 to1959 Time of construction3– between 1960- 7 time dummy variables. 1975 Time of If the dwelling is placed in a building Time of construction4– between 1976- construc- built in a given period, it takes the 1989 tion value 1; Time of construction5– between 1990- otherwise it takes 0). 2000 Time of construction6– between 2001- 2010 Time of construction7 – after 2010 141

Radosław Trojanek / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 137-145 3 time dummy variables. Construc- technology1-traditional brick If the dwelling is located in a building tion tech- technology2 - mixed made of a given material, it takes nology technology3 - prefabricated value 1; otherwise it takes 0. 1- limited right of ownership, Form of ownership ownership 2- full ownership

It takes value 1 for dwellings with the Standard standard lowest standard, and 5 for those with the highest. It takes value 1 for buildings with the Quality of building lowest quality, and 3 for those with building the highest. 1- buildings up to 5 floors Height of Height building 2- buildings above 5 floors

1 – ground and last floor Floor floor 2 - intermediate floors 3 - first and second floor Additional 1 – if there is no basement aarea area 2 – if there is a basement

Source: Own compilation

Then, using GRETL software, we estimated the parameters of functions in which the price of a dwelling was the response variable, while the explanatory variables included the location, construction material, standard, type of ownership, time of construction, floor space, number of rooms and other variables. Table 4 presents the results of the regression function for the equation.

Table 3. The estimates of price function parameters, used observations 1-14164, dependent variable: price log.

regression standard error t-student p value coefficient const 11,3522 0,0143588 790,6071 <0,0001 *** Ddistrict_2 −0,477067 0,00750582 −63,5596 <0,0001 *** Ddistrict_3 −0,260461 0,00665413 −39,1427 <0,0001 *** Ddistrict_4 −0,147571 0,00520647 −28,3438 <0,0001 *** Ddistrict_5 −0,198027 0,00661931 −29,9166 <0,0001 *** Ddistrict_6 −0,266504 0,00587118 −45,3920 <0,0001 *** Ddistrict_7 −0,361504 0,00889893 −40,6234 <0,0001 *** Ddistrict_8 −0,443971 0,0256188 −17,3299 <0,0001 *** Ddistrict_9 −0,271853 0,00653269 −41,6142 <0,0001 *** Ddistrict_10 −0,379562 0,00737574 −51,4609 <0,0001 *** Ddistrict_11 −0,386917 0,00852985 −45,3603 <0,0001 *** Ddistrict_12 −0,174074 0,00656624 −26,5104 <0,0001 *** Ddistrict_13 −0,421542 0,0168894 −24,9589 <0,0001 ***

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Radosław Trojanek / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 137-145 Ddistrict_14 −0,45963 0,0228305 −20,1322 <0,0001 *** Ddistrict_15 −0,187333 0,00902164 −20,7648 <0,0001 *** Ddistrict_16 −0,344587 0,0107282 −32,1199 <0,0001 *** Ddistrict_17 −0,23107 0,00623018 −37,0888 <0,0001 *** Ddistrict_18 −0,131848 0,00780331 −16,8965 <0,0001 *** Dtimeofconstruction_1 −0,0374379 0,0096962 −3,8611 0,0001 *** Dtimeofconstruction_2 −0,100612 0,00796085 −12,6383 <0,0001 *** Dtimeofconstruction_3 −0,153283 0,00674127 −22,7380 <0,0001 *** Dtimeofconstruction_4 −0,143609 0,00717501 −20,0152 <0,0001 *** Dtimeofconstruction_5 −0,108023 0,0067104 −16,0979 <0,0001 *** Dtimeofconstruction_6 −0,0145006 0,00511614 −2,8343 0,0046 *** Dfloor_1 −0,0341829 0,00322587 −10,5965 <0,0001 *** Dfloor_2 −0,0114898 0,00331378 −3,4673 0,0005 *** Dbuilding_1 −0,283078 0,00899395 −31,4743 <0,0001 *** Dbuilding_2 −0,339411 0,00593144 −57,2224 <0,0001 *** Dtechnology_1 0,0460111 0,00549811 8,3685 <0,0001 *** Dtechnology_2 0,0328019 0,00480477 6,8269 <0,0001 *** Dstandard_1 −0,131717 0,00575447 −22,8895 <0,0001 *** Dstandard_2 −0,0926496 0,00560709 −16,5237 <0,0001 *** Dstandard_3 −0,0599494 0,00473797 −12,6530 <0,0001 *** Dstandard_4 −0,0332245 0,0045453 −7,3096 <0,0001 *** area 0,0134715 5,98356e-05 225,1423 <0,0001 *** height 0,0100353 0,0032143 3,1221 0,0018 *** ownership 0,0232209 0,00333514 6,9625 <0,0001 *** area 0,0158152 0,002798 5,6523 <0,0001 ***

Source: Own calculations.

On the basis of the obtained results it may be concluded that the explanatory variables used in the equation explain the fluctuations of dwelling prices in Warsaw in 4th quarter of 2014 in 89%. Moreover, all the variables applied in the model turned out to be statistically relevant. Taking into account the aim of the paper, the statistical relevance of districts variables are important. The application of the log-linear model helps us to identify the percentage difference in the price of the same dwelling located within the district and reference one (in case of this research it is Śródmieście district). In our case, the value of the coefficient with district2 (Białołęka) variable is -0.477, which indicates that a dwelling located in the Białołęka was about 38% (exp(-0,477) -1 ) cheaper than the same dwelling located in Śródmieście in 4th quarter of 2014 in Warsaw. Then the location value of districts indicators were calculated, taking the statistical relationship given by the equation:

Vi=1- [exp(regression coefficient of i-district)/exp(-0,477067)] where:

Vi – location value of i –district.

This procedure allowed us to order the districts taking into account their values. In the table 4 ranking of value district and ranking of districts made by MSO are presented.

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Radosław Trojanek / Montenegrin Journal of Economics, Vol. 11, No. 2 (2015), 137-145 Table 4. Ranking of value district and ranking of districts made by MSO

Place in MSO Value of the Place in our Value of the District District ranking indicator research indicator 1 Śródmieście 0,842 1 Śródmieście 1,00 2 Mokotów 0,678 2 Żoliborz 0,67 3 Ochota 0,673 3 Mokotów 0,64 4 Wola 0,657 4 Ursynów 0,58 5 Żoliborz 0,602 5 Wilanów 0,55 6 Praga-Południe 0,563 6 Ochota 0,53 7 Włochy 0,532 7 Wola 0,46 8 Ursynów 0,518 8 Bielany 0,40 9 Praga-Północ 0,495 9 Praga-Południe 0,38 10 Targówek 0,495 10 Bemowo 0,37 11 Wesoła 0,459 11 Włochy 0,23 12 Wilanów 0,401 12 Praga-Północ 0,20 13 Wawer 0,38 13 Targówek 0,17 14 Bielany 0,359 14 Ursus 0,15 15 Rembertów 0,354 15 Wawer 0,09 16 Bemowo 0,326 16 Rembertów 0,06 17 Ursus 0,3 17 Wesoła 0,03 18 Białołęka 0,265 18 Białołęka 0,00

Source: Own calculations.

The indicator values cannot be compared directly, however they may be useful in looking for similarities and differences between these two researches. The most attractive district in War- saw according to the attractiveness of living conditions was Śródmieście. It turned out that form point of view of value it took a leading position as well. The worst district in MSO research it was Białołęka. In our research this district was characterized by the smallest value. The districts located on the right side of Vistula river had lower value than these on the left side. The results of the research show some similarities but they are not identical. It may be stated that attractiveness of living condition had some reflection in the value of districts.

5. CONCLUSION The aim of the paper is to answer the question to what degree the attractiveness of living in a particular district is reflected in the value of a given area. In this paper, we undertake to compare the attractiveness of the districts of Warsaw (information obtained from the study of MSO) to their value (assessed on the basis of the econometric model of apartment prices). The application of the log-linear model helps us to identify the percentage difference in the price of the same dwelling located within the district and reference one (in case of this research it is Śród- mieście district). The most attractive district in Warsaw according to the attractiveness of living conditions was Śródmieście. It turned out that form point of view of value it took a leading position as well. The worst district in MSO research it was Białołęka. In the research this district was characterized by the smallest value. The districts located on the right side of Vistula river had lower value than these on the left side. The results of the research show some similarities but they are not identical. It may be stated that attractiveness of living condition had some reflection in the value of districts however it is not completely the same. The explanation of this situation may be fact that in MSO research not all of factors influencing the attractiveness of living condition were included.

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