The binding constraint to growth in less developed Western Balkan countries

The overarching objective of the study is the identification of binding constraint to growth of the countries of the Western Balkans (WB).  The region was selected for its combination of underlying structural transformation and systemic transformation problems typical for many European (and some non-European) ‘emerging markets’.After a period of recovery, economic stagnation set in 2009. Since then, growth shows a downward trend. Investment and bank lending are now low impairing the start of a sustained economic growth and catching-up process. A second aim of the study is to take advantage of an adjusted Growth Diagnostics (GD) approach in the quest for the binding constraint to growth. The approach applied here, deviates from the original one and those in the literature on two counts: While the original approach holds a supply-side perspective and is devoted to developing countries, this study, firstly, tests also possible demand constraints to growth, which might matter in countries with some degree of industrialization. Secondly: while the existing literature applies the GD to single countries, the investigation here covers a region of independent countries with some relevant communalities.  These two peculiarities present the novelties to the literature.The  study will be organized in five consecutive steps: Section 1 assesses the applicability of the original GD approach to a region of countries with mixed features: underdevelopment and systemic transformation.  It argues for an adjusted diagnostic tree including possible demand as well as supply side constraints. Sections 2 to 5 present steps in the identification of the binding constraint to growth. It turns out that financial intermediation (section 2), and the size and increase of non-performing loans (NPLs) in the banking sector matters (section 3).  Section 4 opens the focus on the causes of the NPL problem in the World Bank (WB), separating the possible impacts of losses in effective demand and of market and policy failures constituting supply side constraints to growth via NPLs. Section 5 tries to find systematic evidence of the prevailing constraint to lending and growth by running country and panel regressions with quarterly data on lending, NPLs and GDP. Section 6 formulates some policy and methodological implications.

JEL classification: G21, G28