Determinants of Kosovo Trade: A Gravity Model Approach . Determinants of Kosovo Trade: A Gravity Model Approach Florin Peci, Mario Holzner, Enver Kutllovci* Abstract: This study attempts to identify and quantify the factors affecting bilateral trade flows between Kosovo and its trading partner countries using a gravity model. The econometric model is estimated based on both economic and institutional aspects. The results show that family networking with Kosovo emigrants determines to a large extent both exports and imports, while corruption and informality in the partner country seem not to be issues with regard to Kosovo imports. This comes as a surprise given the initial assumption that Kosovo trades more with countries that have a high share of corruption because of informal networks between small and medium enterprises (SME) predominant in Kosovo. The regional CEFTA free trade agreement has a positive effect on both Kosovo imports and exports. Key words: international trade, gravity model, informality, Kosovo JEL: F1, P33, E26 DOI: 10.2478/v10033-010-0013-4 1. Introduction This study aims to analyse the determinants of current institutions have resumed all the responsibilities from the Kosovo trade flows. We have focused on the role of temporary United Nations Administration Mission in specific determinants like institutional and regional Kosovo (UNMIK). Similar to other states in the Balkans, the factors. For this purpose a gravity model was estimated. Republic of Kosovo wants to continue the process of The Republic of Kosovo as a developing country is integration into the European Union. entering a new phase in its history as the newest After the 1999 war in Kosovo the United Nations (UN) independent state in the world. Domestic governmental established UNMIK1, which immediately commenced a liberal policy of trade characterised by simplicity and *Florin Peci impartiality intended to stimulate the private sector and Customs of Kosovo-Prishtine provide for better export conditions. However, this trade E-mail: [email protected] liberalisation was not accompanied with an improvement in the competitive ability of the local producing sectors, Mario Holzner and unfortunately caused a high trade deficit (Riinvest, The Vienna Institute for International Economic 2003). Studies (wiiw), Vienna E-mail: [email protected] Enver Kutllovci 1 UNMIK was established in June 1999 with the promulgation of Faculty of Economics, University of Prishtine UNSC Resolution 1244(1999) to carry out administration of all E-mail: [email protected] sectors of society, including the economy, in Kosovo until a final settlement is found. November 2010 3333 Determinants of Kosovo Trade: A Gravity Model Approach . The break-up of the former Yugoslavia had a strong export sector and the growth of the budget deficit impact on labour markets and migration has changed the (Riinvest, 2003). Kosovo is a consumption economy labour force. Migration flows out and within the area dominated by imports with very low export activity. have become a crucial factor of growth and development Current economic activity is mainly conducted by the in all the countries of the Balkans, especially in Albania private sector, which is small in scale. Relatively large and Kosovo. The large outflows of population brought inflows of remittances are an important source of income significant changes to socio-economic composition and for the economy of Kosovo. demographic trends. For instance, in Albania almost 20 Before 2007, Kosovo had signed FTAs (Free Trade percent of the population has left the country since 1989. Agreements), with many countries in the region. In Kosovo, it is assumed that approximately 25 per cent of Afterwards these agreements were substituted by the the population is currently living abroad (Riinvest, 2007). CEFTA (Central Europe Free Trade Agreement). Kosovo’s The objective of this study is to find out more about membership in CEFTA is an important asset for the the specific determinants of current Kosovo trade flows in country, especially with regard to its European a gravity model context. To our knowledge this has not integration process. CEFTA rules have been harmonized yet been done, also due to the fact that Kosovo Customs with the principles of the EU and the WTO. For Kosovo, has begun collecting higher quality trade data only CEFTA is of paramount importance in improving the recently. Moreover this could provide an informative competitive position of Kosovo’s industries in regional basis for the development of policy recommendations markets and in attracting FDI. In the future process of that could improve the trade balance of Kosovo in a free integration, Kosovo will gear up institutions and policies trade environment. to comply with the requirements of the WTO. Application The study is organised as follows: In part one we will for membership to the WTO is a complex process and provide a general overview on trade policy and trade requires a huge engagement of local institutions. developments in Kosovo. Part two will deal with the However, membership would ensure full integration into gravity model methodology used and the specific world markets (MTI, 2009). hypotheses analysed. In part three we will discuss the However, from the beginning of the implementation results of our research. Part four will provide conclusions of CEFTA, the experience of Kosovo so far has not been and policy recommendations. very positive due to political animosities persisting in the region. UNMIK was a signatory of the CEFTA on behalf of 2. Trade policy and trade developments in Kosovo Kosovo (Kosovo’s international representation and the negotiating process for bilateral FTA-s and CEFTA were conducted by UNMIK representatives), and Serbia and 2.1. Trade Policy in Kosovo Bosnia and Herzegovina do not recognize the institutions of the Republic of Kosovo and the documentation issued In Kosovo, under the general economic policy of by them. As a consequence, Kosovo’s exports to these UNMIK, unique and specific fiscal and custom policies countries have been almost at a stand-still for a long time, were created starting with the creation of comprehensive although there are ongoing efforts to resolve these custom and taxation control of imported goods and issues. establishment of a functioning flexible trade regime with It has to be mentioned that the trade policies in the rest of the world. 2 Kosovo have been developed in specific circumstances, in However, it is evident that the economy of Kosovo after a speedy and simple way, by using the Customs of the war in 1999 faced many problems that derive from Kosovo as an instrument for realizing the main objective the sphere of the political and institutional set-up, of gathering income for Kosovo’s consolidated budget including a privatization process accompanied by high (UNMIK, 2006). However, with the new state the general unemployment rates, excessive import growth, a weak economic situation has changed. The new circumstances under which Kosovo businesses have developed require 2 According to UNMIK (1999): ‘UNMIK, from the beginning of the mission in Kosovo, was determined on a simple trade regime with a two level the application of new forms of procedures and new customs tax: 10% in value for all imported goods according to customs general regulations as provided by the basic principles of tariff, vis-a vis goods that are released from the payment of customs the WTO. obligation, a 0% rate. Also since July 1, 2001 this includes the value added tax (VAT) of 15% on value as well as the excise tax on quantity for specific goods’. 34 SEE Journal Determinants of Kosovo Trade: A Gravity Model Approach . 2.2. Kosovo Trade Performance total imports; the rest were imports of different goods (CBK, 2008). An increase of imports of capital goods Data published by the Statistical Office of Kosovo consisting of machinery, tools and equipment used (SOK) on external trade provide the following picture. In mainly for production, indicates that productive activity the period 2001-2008, Kosovo had a negative trend in its in Kosovo is increasing. The economic growth of Kosovo trade balance, which by the end of 2008 reached €1730 in 2007 of 3.5 percent is rather low when compared with million (SOK, 2008). In 2008, imports amounted to €1928 other countries in the region which reached GDP million as a result of higher domestic demand. Based on increases of more than 6 percent in 2007 and less than 6 the 2008 Report of the Central Bank of Kosovo, the trade percent in 2008. Kosovo’s economy is small, highly open deficit in Kosovo had reached 43 % of GDP by the year with imports being around 60% of GDP, and by poor by 2008 (CBK, 2008). At the same time, exports in 2008 had regional standards with GDP per capita around $1,448 per reached the value of only €198 million. In 2008 exports year (MEF, 2007). In Kosovo in 2008 there was a covered imports by only 10%. In the same year exports somewhat higher increase of GDP by 5.4 percent (CBK, increased by 20%, while imports increased by as much as 2008). Foreign direct investment (FDI) in 2007 made up 22%. €114 million, or approximately 5 percent of GDP (MTI, The composition of the goods exported from Kosovo 2007). in 2008 was generally dominated by raw materials and Kosovo exports at the beginning of 2000 mainly metals which accounted for around 63 percent of general targeted countries in the region due to many institutional exports. Chemical products, alcoholic beverages and and managerial insufficiencies, as well as the lack of tobacco accounted for around 32 percent of total exports, knowledge and experience of foreign markets among while livestock, food, fuel, machinery and other transport local exporters. Nevertheless, with time, these difficulties equipment, and other raw materials in small quantities have been reduced.